Open AccessDemonetization: did India face the St. Petersburg paradox and lose
Author(s) -
Rajaram Gana
Publication year - 2017
Publication title -
journal of governance and regulation
Language(s) - English
Resource type - Journals
eISSN - 2306-6784
pISSN - 2220-9352
DOI - 10.22495/jgr_v6_i4_p3
Subject(s) - cash , argument (complex analysis) , face value , rationality , economics , counterfeit , irrational number , currency , law , law and economics , monetary economics , finance , political science , biochemistry , chemistry , geometry , mathematics
In 2016, India demonetized 24% of its currency notes (viz. 86% in cash value) in circulation presuming this will remove “black” (illicit) and counterfeit cash holdings, and combat money laundering. This was the largest demonetization experiment in recent history. Although demonetization has occurred several times before, no unambiguous economic argument for, or against, it exists. This was a key enabler for demonetization, yet again. This paper argues that the St. Petersburg Paradox (SPP) provides a compelling argument against demonetization. Assuming the distribution of cash is lognormal, it is shown that the probability of black cash holdings will be small. If not, the holders would: a) be irrational because they are willing to accept, contrary to the SPP, the small probability of a large loss, by effectively perceiving it as zero, without using all means to immunize themselves against it; or b) be sure their cash can be legitimized via collusion with the State; or c) be sure they can incentivize law-abiding citizens to act as agents to legitimize the cash for a reasonable fee. Assuming rationality and no bureaucratic support, large probabilities of black cash holdings imply that many more law-abiding patriotic citizens have to be corruptible than seems rational.