DEMONETIZATION: DID INDIA FACE THE ST. PETERSBURG PARADOX AND LOSE?

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Abstract

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.

Keywords: St. Petersburg Paradox, India, Demonetization, Black Money, Corruption, Law-abiding Citizen, State Collusion, Rationality

Received: 28.09.2017

Accepted: 23.11.2017

How to cite this paper: Gana, R., (2017). Demonetization: did India face the St. Petersburg paradox and lose? Journal of Governance & Regulation, 6(4), 30-38. https://doi.org/10.22495/jgr_v6_i4_p3