“On the day the announcement was made, there was this huge bunching going on,” Chintagunta says. By buying pricey items such as appliances, consumers avoided the costs associated with exchanging expiring notes at banks.
Some people kept their purchases, which they might have otherwise made later. But others, through “strategic returns,” swapped the cash-purchased items for the new currency, thus avoiding bank-related exchange costs. Among purchases made in the hours after the announcement that were later returned, nearly 80 percent were made with cash. This suggests consumers were motivated to use banned notes to buy goods and later receive legal notes for the returns, as only cash sales could be refunded with cash under the chain’s policy, the researchers note.
For consumers, the policy change proved largely inconvenient. Media coverage showed people waiting in long lines at banks so they could buy food and other necessities. Those who avoided banks nonetheless suffered due to the additional steps they had to go through to convert their currencies to the new one. “The objective—transparency—was a good one,” Chintagunta says. “In reality, it caused a lot of hardship for people who really did not have any ill intentions and were not doing things illegally.”
For policy makers, the move was largely a disappointment. Within six months of the announcement, nearly 99 percent of the old notes were returned to the Indian banking system without any significant short-term increase in the number of taxpayers or direct tax revenues, calling into question the policy’s effectiveness.
“Our analysis suggests that strategic consumers hindered the intended policy effect while partly benefiting the retail chain,” write Kim, Chintagunta, and Pareek. This left 20 million rupees (US$300,000) of demonetized notes outside the formal tax network through this one retail chain. Scaling up the amount falling through the cracks on the basis of India’s market size increases the estimate to 100 billion rupees, or around 20 percent of that year’s budget of Delhi, the researchers calculate.
The retailer enjoyed some extra sales, although not as many as it would have had it known of the policy beforehand. With time to stock up on supplies and launch advertising campaigns, the retailer could have seen an even larger spillover effect, suggest the researchers.
The researchers say they hope understanding the microlevel consequences of macrolevel government intervention will help lawmakers better craft monetary reforms to stem illicit financial flows—and perhaps transition to a cashless society, as many governments are now pondering whether and how to do.
Kim says that while the research contains lessons for countries considering making financial reforms, the implications can go further: “We hope this can open more rich discussions about unintended consequences of other macroeconomic or market-level policies.”