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JMLC
22,4 The hoax of demonetization
in Indian economy: a
mathematical analysis
678 Debasish Roy
Department of Management, Sikkim University, Gangtok, India

Abstract
Purpose – Over one and half years have passed since the demonetization of Indian economy had occurred
on November 8, 2016. The drastic step was initiated by the Prime Minister Narendra Modi with an intention to
curb the “huge” circulation of illicit or “black” money of Indian economy by means of withdrawal of high
value denominations of Rupees 500 and Rupees 1,000 from the supply of broad money (M3). This step helped
to demonetize around 86 per cent value of total money supply leading to an unprecedented chaos in the
economy and public life. The long delays in issuing fresh currency notes at the banks and ATMs further
deteriorated the sudden economic crisis.
Design/methodology/approach – This research paper is aimed at exploring the proclaimed “efficacy”
of demonetization policy as proposed by Reserve Bank of India by means of a mathematical approach and
critically examines the effects of demonetization on the illicit money supply of Indian economy on the basis of
macroeconomic theory.
Findings – From the mathematical model and related estimates, it may be easily deduced that the Indian
policymakers deliberately hurled the masses in one of the gravest economic crises with a clear-cut intention of
creating a political gimmick, when in reality, the proportion of illegitimate money supply was not even 1
per cent of total legitimate supply of money.
Originality/value – The analyses and findings related to this paper are based on mathematical modeling
and logical interpretations. This paper is free of plagiarism as all the necessary sources and references are
properly cited.
Keywords Illicit nominal income (YL), Illicit supply of money (MI), Legitimate nominal income,
Legitimate supply of money (ML), Velocity of circulation of illicit money supply (vL),
Velocity of circulation of legitimate money supply (vI)
Paper type Research paper

Journal of Money Laundering
Control
Vol. 22 No. 4, 2019
pp. 678-693
© Emerald Publishing Limited
1368-5201
DOI 10.1108/JMLC-11-2018-0068
Introduction
Post-independence India’s first experience with demonetization was on January 16, 1978 when
the currency notes of higher denominations of Rupees 10,000, Rupees 5,000 and Rupees 1,000
by an ordinance of the President of India (Rajakumar and Shetty, 2016) with the identical
intention of eliminating “the possible use of such notes for financing illegal transactions” (RBI,
1977-78: 77). However, there was a major difference between the demonetization drives of 1978
and 2016. In 1978, only 0.6 per cent of high denomination notes were in circulation compared to
around 86 per cent in 2016 (Refer to Table I). Moreover, in 1978, about 45 per cent of the high
value notes for demonetization were with the banks and government treasuries as compared to
just Rupees 96,080 crore (approximately US$15bn for exchange rate of US$1 = Indian Rupees
64) or about 5 per cent of high value notes for demonetization were with the banks and
government treasuries in 2016 (Refer to Table II). Despite the claim of Reserve Bank of India
JEL classification – C30, C39, E26, E52, H11
 Total notes as on Note tendered for Amount passed for
16 January 1978 conversion to exchange for lower Col (2) as % Col (3) as %
(` crore) RBI (` crore) denomination (` crore) of Col (1) of Col (1)
(1) (2) (3) (4) (5)

Total value of HD notes 145.42 124.45 116.31 85.6 80.0

Of which held by
(1) Banks and
government treasuries 64.94 64.94 61.24 100.0 94.3
(2) Public 80.48 59.51 55.07 73.9 68.4
Public as % of total 55.3 47.8 47.3
Notes: HD notes refer to high denomination notes comprising `1,000, `5,000 and `10,000. Cols (2) and (3) are based on notes tendered for conversion to the RBI,
as on 30 June 1978
Source: Reserve Bank of India, Annual Report 1977-78, p. 38

(’000, 0000)]
demonetization in
Profile of
in Indian
demonetization

679
Hoax of

1978 [in rupees crore

Table I.
economy
 22,4

0000)]
680
JMLC

Table II.

components
supply and its

[outstanding in
rupees crore (’000,
Movements in money
Currency with public Demand deposits Other deposits with RBI M1 Time deposits M3

Outstanding as on March 31 (in ` crore)

2006 3,56,314 2,86,998 6,454 6,49,766 15,95,887 22,45,653
2016 15,98,095 9,97,021 15,451 9,97,021 90,43,773 19,94,042
Absolute variations (in ` crore)
2005-2006 55,810 (15.7) 1,20,425 (42.0) 389 (6.0) 1,76,624 (27.2) 2,97,217 (18.6) 4,73,841 (21.1)
2006-2007 70,730 (17.2) 70,181 (17.2) 624 (9.1) 1,41,535 (17.1) 4,49,009 (23.7) 5,90,544 (21.7)
2007-2008 85,556 (17.7) 1,00,768 (21.1) 1,560 (20.9) 1,87,884 (19.4) 5,19,933 (22.2) 7,07,817 (21.4)
2008-2009 97,040 (17.1) 10,316 (1.8)
3,494 (
38.7) 1,03,862 (9.0) 6,73,059 (23.5) 7,76,921 (19.3)
2009-2010 1,02,042 (15.3) 1,29,282 (22.0)
1,727 (
31.2) 2,29,597 (18.2) 5,78,325 (16.4) 8,07,922 (16.9)
2010-2011 1,44,344 (18.8) 4,886 (0.7)
153 (
4.0) 1,49,077 (10.0) 7,52,341 (18.3) 9,01,418 (16.1)
2011-2012 1,11,834 (12.3)
11,954 (
1.7)
831 (
22.7) 99,049 (6.0) 7,81,666 (16.1) 8,80,715 (13.5)
2012-2013 1,17,391 (11.5) 42,323 (6.0) 418 (14.8) 1,60,132 (9.2) 8,44,856 (15.0) 10,04,988 (13.6)
2013-2014 1,04,758 (9.2) 58,753 (7.8)
1,275 (
39.4) 1,62,236 (8.5) 9,65,331 (14.9) 11,27,567 (13.4)
2014-2015 1,40,363 (11.3) 79,654 (9.8) 12,625 (642.5) 2,32,642 (11.3) 8,00,140 (10.7) 10,32,782 (10.9)
2015-2016 2,11,913 (15.3) 1,05,389 (11.8) 861 (5.9) 3,18,163 (13.9) 7,86,009 (9.5) 11,04,172 (10.5)
Variations: As % to M3
2005-2006 11.8 25.4 0.1 37.3 62.7 100
2006-2007 12.0 11.9 0.1 24.0 76.0 100
2007-2008 12.1 14.2 0.2 26.5 73.5 100
2008-2009 12.5 1.3
0.4 13.4 86.6 100
2009-2010 12.6 16.0
0.2 28.4 71.6 100
2010-2011 16.0 0.5 0.0 16.5 83.5 100
2011-2012 12.7
1.4
0.1 11.2 88.8 100
2012-2013 11.7 4.2 0.0 15.9 84.1 100
2013-2014 9.3 5.2
0.1 14.4 85.6 100
2014-2015 13.6 7.7 1.2 22.5 77.5 100
2015-2016 19.2 9.5 0.1 28.8 71.2 100

Note: Figures in paranthesis are percentage variations

Source: Based on data extracted from RBI (2016b), Handbook of Statistics on Indian Economy 2015-2016
(RBI) regarding increased incidence of fake notes in circulation of broad money supply which are Hoax of
used by terrorists and hoarders of illicit money, only a meager 0.002 per cent of circulation of demonetization
money constituted of fake currencies (Rajakumar and Shetty, 2016). In case of Indian economy,
the “narrow” money (M1) primarily consists of currency held with public, demand deposits, and
in Indian
other deposits with the RBI, while the “broad” money (M3) has an additional component of time economy
deposits. The ratio of currency held by public to M3 (commonly referred to as Income Velocity)
has shown a declining trend over the years. However, during the time period 2013-2014 to 2015-
2016, the share of M1 doubled from 14.4 per cent to 28.8 per cent as one of the components of M3 681
accompanied by a simultaneous reduction in the share of time deposits. In case of M1, the share
of currency with public went up from 9.3 per cent to 19.2 per cent, and share of demand deposits
showed a lesser growth rate from 5.2 per cent to 9.5 per cent within the same time span. From the
figures above, it may be clearly interpreted that the major contributor of growth of money supply
in Indian economy was the significant growth in currency held by public (Refer to Table II).
Primarily, three major factors could be attributed to the relative higher growth rate of currency
with public as compared to the growth rate of demand deposits, and they are as follows:
(1) Within the last decade or so, there has been a consistent growth in the income
levels of working-class population of India, especially the youth work - forces
associated with the Information Technology (IT) and Information and
Communication Technology (ICT) sectors. Thus buoyed by a spurt in the income
levels, the disposable incomes of working-class population also increased steadily
resulting in higher shares of currency with public,
(2) With increased income levels, people across different strata of Indian society got
inclined to invest heavily in alternative channels with greater prospects of Return
on Investment (ROI) like stock markets, mutual funds etc., thereby shifting the
pattern of investment from traditional demand deposits with commercial banks,
post office etc. which usually offer much lesser ROI (Risk-free interest rates), and
(3) In apprehension of higher inflation rates in future, people indulged in saving idle
-cash or liquid balance in order to meet unforeseen contingencies leading to an
increase in the pecuniary demand for money.
Thus without giving due importance to the factors leading to high growth rates of currency
held by public as mentioned above, the Indian policymakers apparently opted for a drastic
step which suffered both in terms of policy formulation and policy implementation.
This research paper is aimed at analyzing the validity of the proclamation of
demonetization by the Government of India, i.e. the “alarming increase” of black money as a
proportion of legitimate money supply (which are used for “terror funding” and other
illegitimate purposes) based on a simple mathematical model supplemented by official
government data and research findings.
Literature review
The most comprehensive definition of illicit/underground/black/shadow economy is given
by Medina and Schneider (2018) as:
The shadow economy includes all economic activities which are hidden from official authorities for
monetary, regulatory and institutional reasons. Monetary reasons include avoiding paying taxes and
all social security contributions, regulatory reasons include avoiding governmental bureaucracy or the
burden of regulatory framework, while institutional reasons include corruption law, the quality of
political institutions and weak rule of law.
In accordance to the scholarly works by Gerxhani (2003), Feld and Schneider (2010),
Schneider (2011, 2015, 2017), Schneider and Williams (2013), Williams and Schneider (2016),
JMLC and Hassan and Schneider (2016); Medina and Schneider’s (2018) recent IMF Working Paper
22,4 encompasses the major procedures of estimating the quantum of shadow economy such as
Multiple Indicators Multiple Causes (MIMIC), Currency Demand Approach (CDA) and
Predictive Mean Matching Method (PMM) as derived by Rubin (1987). Hence, Medina and
Schneider’s (2018) elaborative research work has been treated as the “benchmark” for
writing this research paper.
682 The highlights of Medina and Schneider’s (2018) paper are obvious inclusions of direct
and indirect approaches of measuring the shadow economies across the world spanning 158
countries for the time period of 25 years (1991-2015).
Direct approaches
Under the broad ambit of direct approach, there are four major categories:
(1) Measurement by the System of National Accounts (SNA) statistics-Discrepancy
method;
(2) Survey technique approach;
(3) The use of surveys of company managers; and
(4) The estimation of the consumption-income-gap of households.

The four categories mentioned above are discussed briefly below.

System of national account statistics-discrepancy method
Gyomai and van de Ven’s (2014) seminal work has demonstrated five major categories of the
non-observed or shadow economy as follows:
(1) Underground hidden production: It refers to those activities which are legal and
help in value-added method of estimation of GDP, however, they are deliberately
concealed from the public authorities;
(2) Illegal production: It refers to those activities which are directly involved in
production of goods and services forbidden in the eyes of law and carried out by
unauthorized activities;
(3) Informal sector production: It refers to those activities related to the goods and
services produced/rendered by the incorporated firms in the household sector
which, although registered, provide spurious data about their labor forces by
concealing the actual figures;
(4) Production of households for own (final) use: It refers to those activities related to
the goods and services produced/rendered by the households for their end usages
and/or own consumption;
(5) Statistical “underground”: It includes those productive activities which should be
included in basic data collection programs, however, in practice, they are ‘omitted’
during the statistical surveys.
The following flow-chart (Ven van de, 2017) would help to throw light on the classification
of Non-Observed Economy (NOE) (Refer to Figure 1):
Figure 1 provides the decomposition of the following non-observed economy categories:
 Economic underground: N1 þ N6.
 Informal (and own account production): N3 þ N4 þ N5.
 Statistical underground: N7.
 Illegal: N2.
 Hoax of
demonetization
in Indian
economy

683

Figure 1.
Classification of NOE
(non-observed
economy)

By calibrating the types of NOE informalities, it was found that the shares of NOE as a per
cent of GDP for the major 16 developed nations of OECD differed in large extents (2011-
2012). Italy topped the list with 17.5 per cent of GDP as NOE and Norway was at the bottom
of the list with merely 1 per cent of GDP as NOE (Refer to Table III).

Micro approach: representative surveys

Representative surveys are generally used to analyze the natures of shadow labor markets
in terms of micro approach. A survey conducted by Lithuanian Free Market Institute and its

Informal Statistical
Underground Illegal sector deficiencies Total
N1 þ N6 N2 N3 þ N4 þ N5 N7 NOE

Austria 2.4 (31.7) 0.2 (2.1) 1.5 (19.4) 3.5 (46.8) 7.5 (100)
Belgium 3.8 (83.8) – – 0.7 (16.2) 4.6 (100)
Canada 1.9 (88.2) 0.2 (8.2) – 0.1 (3.6) 2.2 (100)
Czech Rep. 6.3 (77.6) 0.4 (4.5) 1.3 (15.6) 0.2 (2.3) 8.1 (100)
France 3.7 (54.7) – 2.9 (42.7) 0.2 (2.7) 6.7 (100)
Hungary 3.1 (27.9) 0.8 (7.5) 3.1 (28.6) 3.9 (36) 10.9 (100)
Israel 2.2 (32.6) – 1.4 (21.8) 3 (45.6) 6.6 (100)
Italy 16.2 (92.8) – – 1.2 (7.2) 17.5 (100)
Mexico 5.5 (34.7) – 10.4 (65.3) – 15.9 (100)
Netherlands 0.8 (36.6) 0.5 (20.1) 0.5 (20) 0.5 (23.2) 2.3 (100)
Norway 0.5 (51.5) 0 (0.3) 0.5 (43.8) 0 (4.4) 1 (100) Table III.
Poland 12.7 (82.6) 0.9 (6) 0 (0) 1.8 (11.4) 15.4 (100) NOE Adjustments by
Slovak Rep. 12.1 (77.3) 0.5 (3) 2.9 (18.7) 0.2 (1) 15.6 (100) informality types –
Slovenia 3.9 (38.2) 0.3 (3.2) 2.8 (27.7) 3.1 (30.9) 10.2 (100)
Sweden 3 (100) – – – 3 (100)
as percentage of GDP
UK 1.5 (65.6) – 0.5 (22.9) 0.3 (11.4) 2.3 (100) (share of adjustment
type within total
Source: Gyomai and van de Ven (2014, p. 6) NOE); 2011-2012
JMLC partner organizations across 6 nations which included 6,000 respondents between the age
22,4 group of 18 to 75 years revealed the facts that Belarus enjoyed the highest share of shadow
employment (32.8 per cent of GDP) followed by Poland (24 per cent of GDP), whereas
Sweden was least affected in terms of shadow employment (a meager 1.7 per cent of GDP).

Micro approach: measuring the shadow economy using surveys of company managers
684 Studies by Putnins and Sauka (2015) and Reilly and Krstic (2017) regarding surveys of
company managers helped to open another vista regarding measurement of shadow
economy. The basic concept behind their studies are founded on the conjecture that
company managers are the most efficient corporate representatives who can “correctly”
predict misreported/unreported business incomes along with the number of unregistered/
hidden employees and the quantum of unreported wages as well. Hence, their method
combines estimations of misreported/unreported business incomes, number of unregistered/
hidden employees and the quantum of unreported wages as a percentage of GDP. By using
this method, for a sample size of 3 countries, Putnins and Sauka showed that on an average
27.8, 17.4, and 16.4 per cent of GDPs’ consisted of shadow economies for Latvia, Estonia, and
Lithuania respectively for the time period 2009 to 2015.

Indirect approaches
Indirect approaches are alternatively termed as “Indicator” approaches as these methods are
mostly based on certain indicators related to the macroeconomic aspects of an economy.
The indirect approaches are broadly classified into six categories:
(1) Discrepancy between national expenditure and income statistics: The people
working in the shadow economy mostly tend to evade taxes rather than putting a
leash on consumption, hence the difference between national income and national
expenditure estimates could be used to estimate the size of the shadow economy.
This approach assumes that there is no error in terms of estimating the national
expenditure and the individual components are independent of income factors
(MacAfee, 1980; Yoo and Hyun, 1998);
(2) Discrepancy between official and actual labor force: In this method, the quantum of
shadow economy is measured as the rate of decline of labor participation rate by
keeping the total labor participation rate unchanged. The causal factors for
fluctuations in labor participation rate like business cycle, education level,
difficulty in finding jobs and retirement are deemed to be weak indicators as
compared to the negative growth rate of labor participation rate (Contini, 1981; Del
Boca, 1981; O’Neil, 1983);
(3) Electricity approach: Kaufmann and Kaliberda (1996) argued that electricity
consumption may be treated as the best physical indicator for measuring overall
(both official and unofficial) economic activity. By using the findings that
electricity consumption to overall GDP elasticity is approximately 1, these
researchers have suggested that the size of the shadow economy may be measured
by the proxy variable as the difference between the growth of consumption of
electricity and the growth of GDP.

However, this procedure was subject to major criticism on two grounds:

 Not all the economies are dependent on consumption of electricity since there are
other available sources of energy, such as coal, fuel etc.
  The electricity consumption to overall GDP elasticity may differ across countries Hoax of
over time (Del Boca and Forte, 1982; Portes, 1996; Johnson et al., 1997); demonetization
(4) Transaction approach: This method uses Fisher’s Quantity equation of exchange, in Indian
i.e., Money supply (M) * Velocity of circulation of money (V) = Price (P) * Output/ economy
Official GDP (Y), in a modified manner like below:

M  V ¼ P  Y ¼ kðY þ Shadow economyÞ 685

where k = 1/V = Reciprocal of velocity of circulation of money = constant.
From the given equation, the size of the shadow economy can be easily estimated
given the values of M, V, k and Y. However, this procedure has its major weaknesses
in the sense that the value of “k” may not remain stationary over time and a fall in
the velocity of circulation of money may be attributed to the increased usages of
debit/credit cards or online transactions or both;
(5) Currency Demand Approach (CDA): Tanzi (1980) has suggested that the “excess”
demand for currency may be regressed as a function of conventional factors like
evolution of income, payment practices, direct and indirect burdens of taxation,
government regulation etc. since an excess demand for currency may be associated to
a growth of shadow economy. However, this method is prone to weaknesses, such as:
 All illegitimate transactions do not occur with liquid cash as the only medium
of exchange;
 Lesser growth of demand deposits with public accompanied by a higher
growth in the currency held by the public may occur due to the paradigm shift
in the asset-holding pattern of the consumers as consumers might start
preferring holding idle cash to meet the contingency needs; and
 The assumptions of same velocity of money circulation for both the formal and
informal economies and absence of shadow economy at the base year of time
series are quite arbitrary and unrealistic in nature.
(6) Multiple Indicators, Multiple Causes (MIMIC) approach: The MIMIC model is a
special type of structural equation modeling (SEM) based on the statistical theory
of unobserved variables developed by Zellner (1970) and Joreskog and Goldberger
(1975). The pioneers of application of SEM for estimation of shadow economies
across 17 countries within OECD were Frey and Weck-Hanneman (1984) followed
by Schneider et al. (2010), Hassan et al. (2016), and Buehn et al. (2009).

The MIMIC model is divided into two parts: the structural model and the measurement
model. The necessary steps to construct the MIMIC model are given below (Refer to Figure 2):
 The shadow economy is treated as a latent variable;
 Define the latent variable (shadow economy) as a function of causal variables-which
forms the structural model; and
 Define another dependent variable which is a function of the latent variable-which
helps to form the measurement model. Formally:

h ¼ CXþ z (1)

Y¼Kh þ« (2)
JMLC
22,4

686

Figure 2.
MIMIC estimation
procedure

By plugging the value of “ h ” from equation (1) into equation (2), we have:
Y ¼ KðC X þ z Þ ¼ a X þ b (3)
where:
h = Latent variable (shadow economy);
X = Row vector of causes in the structural model;
Y = Row vector of indicators in the measurement model;
C = Coefficient column matrix of causes in the structural model;
K = Coefficient row matrix in the measurement model;
z = Residual in the structural model;
« = Residual in the measurement model;
a = K  C = Coefficient (column) matrix of the causes of shadow economy; and
b = K  z = Residual of the regression equation (column matrix).
The MIMIC method only helps to estimate “relative” weights of different causal variables.
The statistically confirmed results about the causal relationships between the shadow
economy and the independent variables may not be established.
Hence in order to rectify these shortcomings, Dybka et al. (2017) developed a hybrid
model based on the concept of “reverse standardization”. It helps to overcome the
shortcomings of MIMIC method mainly by two ways:
(1) The problem of choosing an external referencing point of benchmarking is overcome
by providing the panel-structured information on the latent variable’s mean and
variance obtained from the CDA estimates; and
(2) The issue of negligence of the negative variances in the MIMIC model is tackled
appropriately-which in fact helps to flatten the trajectory of shadow economies.

While estimating the “actual” sizes of shadow economies across nations, the problem of
“double accounting” is embedded in every measuring technique regardless of its application.
 In the methods like MIMIC or CDA, the causal factors like tax-burden, unemployment, Hoax of
regulation etc. help to indulge people in “do-it-yourself” activities which is practiced among demonetization
people by demonstrating real-life examples. Thus, these macro approaches include do-it-
yourself activities, neighbors’ help, legally purchased materials and smuggling.
in Indian
The results for macro MIMIC and adjusted MIMIC estimates of shadow economies for 31 economy
European countries for 2017 are shown below (Refer to Figure 3).

Night lights intensity approach

687
The MIMIC model of measuring shadow economies is subject to criticism broadly on three
grounds:
(1) The use of GDP per capita and growth of GDP per capita as causes and indicator
variables.
(2) The dependence of another independent study to calibrate the standardized values
to percentage of GDP in order to estimate the extent of shadow economies.
(3) The estimated coefficients are subject to sensitivities regarding the factors like
country sample and chosen time periods.

In an attempt to overcome the shortcomings as mentioned above, Henderson et al. (2012)

proposed the night lights approach under the conjecture that the intensity of night lights
acts as a causal factor for the economic activities. They used data on light intensity from
outer space as a proxy for the “true” economic growth achieved by countries.
This method has a benefit over the traditional methods of estimating shadow economies
under MIMIC in the sense that it completely eliminates the ambiguities of double accounting
in GDP estimates as well as the introduction of GDP growth rate as the causal variable for

Figure 3.
Size of the shadow
economy of 31
European countries in
2017-macro and
adjusted MIMIC
estimates
JMLC calibrating shadow economies. Although night-lights approach has its benefits, but it is not
22,4 free from criticism as well, such as, in the rural areas, economic activities usually do not
depend on extra source(s) of electricity.

Predictive mean matching method

The major thrust area of PMM method (Rubin, 1987) is based on the concept of “missing
688 data” problem for estimation of the sizes of shadow economies. Missing data may result due
to three types of mechanisms, namely:
 Missing Completely At Random (MCAR);
 Missing At Random (MAR); and
 Missing Not At Random (MNAR).

The PMM method is based on the hypothesis that the missing data are of MAR nature for
estimation of the shadow economies. The assumption is quite realistic in the sense that it
states that the probability of missing data for a shadow economy depends on the inherent
characteristics of that shadow economy itself, and not its size.
The major problem in empirical estimation of shadow economies is the heterogeneity
factor in institutional constraints. PMM method evades this problem by producing multiple
datasets in a Bayesian framework. The other advantage of PMM technique is that in its
actual process of estimation, it becomes non-parametric in nature. It does not suffer from the
inherent problem of matching dissimilar countries with identical co-variates or causal
variables under the assumption of uniform co-variate extrapolation. Based on the
similarities and dissimilarities among the countries depending on the factor of availability of
data, the countries are matched accordingly. The similarity principle for PMM is based on
the following Classical Linear Regression Model (CLRM) by Ordinary Least Squares (OLS)
method as below:

Yit ¼ a þ b GE0  GE0 þ b RQ  RQ þ b C  C þ b ROL  ROL

þ b BF  BF þ b SE  SE þ b HDI  HDI þ b E  E

where:
Yit = Shadow economy of country i (as a percentage of GDP) in time t;
GE0 = Government Effective Index;
RQ = Regulatory Quality Index;
C = Corruption Index;
ROL = Rule of Law Index;
BF = Business Freedom Index;
SE = Self-employment levels;
HDI = Human Development Index; and
E = Education variable.
When MIMIC and PMM samples are divided into three broad categories of countries, such
as, specifically “lower than 20 per cent of GDP”, “between 20 and 40 per cent of GDP”, and
“higher than 40 per cent of GDP”, most sample countries tend to coincide between samples
(over 60 per cent) to project consistency between the two methods.
Thus from the entire discussion, it may be clearly interpreted that demonetization should
not be treated as the ‘ideal’ economic tool to combat an extremely complicated and sensitive
issue of shadow economy or curbing the illicit supply of money in the system.
 The following simple mathematical model would help the audience to clearly understand Hoax of
the futility of a drastic and hasty measure like demonetization in the light of an enormous demonetization
money market-driven economy like India. in Indian
economy
The model
When Indian policymakers predominantly emphasized on the idea of demonetization to
“curb” the menace of illicit supply of money in the Indian economy, the said move was
689
clearly aimed at the “transaction approach” to address the issue of generation of “black” or
illicit money in the economy. Hence following Fisher’s (1922) basic Quantity equation of
exchange, the following model is structured as a set of equations.
At equilibrium condition of money market, it may be expressed as:

MV ¼ PY

where:
M = Supply of money;
V = Income velocity of money;
P = Price level; and
Y = Income (Nominal GDP).
Now, let the money supply of the economy is broadly divided into two parts: Legitimate and
Illicit supply of money. Following this “method”, it may be assumed that the nominal GDP
(Y) could be also divided into categories:
 Legitimate nominal GDP-which is officially estimated by the government; and
 Illicit nominal GDP-which is the sum of all shadow economic activities.

Thus, the necessary set of equations for the model may be introduced as:

ML ¼ l YL (1)

MI ¼ ð1
l ÞYI (2)

YL ¼ VL ML (3)

YI ¼ V I MI (4)

and

M ¼ ML þ MI (5)

where:
ML = Legitimate supply of money;
l = Fraction of legitimate supply of money in circulation (0 < l < 1);
YL = Legitimate nominal GDP;
MI = Illicit supply of money;
VL = Velocity of circulation of legitimate supply of money; and
VI = Velocity of circulation of illicit supply of money.
JMLC Again, let VI = r VLwhere r = Vector (Ratio of velocities of illicit and legitimate supplies of
22,4 money). ( r > 0)
From equation (3):

YL ¼ l VL YL

(Since ML = l YL)
690
! l VL ¼ 1 (6)

Again from equation (4):

Y I ¼ V I MI

! YI ¼ ð1
l ÞVI YI

[Since MI = (1
l ) YI]

! ð1
l ÞVI ¼ 1
(7)
! ð1
l Þ r VL ¼ 1

(Since VI = r VL)
By comparing equations (6) and (7), it may be deduced that:
l VL ¼ ð
l Þ r VL

! l ¼ ð1
l Þ r

! l ð1 þ r Þ ¼ r

! l ¼ r =ð1 þ r Þ

By substituting the value of “l ” in equation (2), we have:

MI ¼ ½1
ð r =1 þ r ÞYI 
(8)
! MI ¼ YI =ð1 þ r Þ

Now according to Rajakumar and Shetty (2016), only 0.002 per cent of supply of money
constituted of fake or illicit currencies. Hence l = 1
0.002 = 0.998.
Hence:
l ¼ r =ð1 þ r Þ ¼ 0:998

! 0:002 r ¼ 0:998

! r ¼ 499
As VI = 499 VL, it gives us: Hoax of
YI ¼ 499 VL MI ; and demonetization
YL ¼ VL ML :
in Indian
economy
Hence YI =YL ¼ 499 VL MI =VL ML
(9)
! YI =YL ¼ 499  ðMI =ML Þ 691
Now according to the MIMIC estimates for the time period 1991 to 2015 (Medina and
Schneider, 2018, p. 72), an average of 23.91 per cent or approximately 24 per cent of Indian
economy (GDP) was illicit in nature.
Thus it may be clearly inferred that for Indian economy, YI = YL  0.24.
Finally, by substituting the value of (YI = YL) in equation (9), it may be derived that:
499  ðMI =ML Þ ¼ 0:24
! MI = ML = Ratio of illicit money supply to legitimate supply of money  0.00048.

From the calculations above, it may be easily deduced that the Indian policymakers
deliberately hurled the masses in one of the gravest economic crises with a clear-cut
intention of creating a political gimmick, when in reality; the proportion of illegitimate
money supply was not even 1 per cent of total legitimate supply of money.

Conclusion
Chomsky (2017) in his seminal work “Requiem for the American Dream” has highlighted 10
major principles of concentrating wealth and power in American society. Out of those ten
principles, three principles, namely “Shaping of ideology”, “Redesigning of the economy”,
and “Shifting the (economic) burden on poor” should be given prime importance to
transform the nation into a dictatorial state or a “Banana Republic”. Although written in the
perspective of American economy, it is equally, if not more, applicable for Indian economy
as well. Like any other political rhetoric (seemingly impossible to materialize in the real
world scenario) regardless of its timing and strength, has its own expiry date. When the
expiry date draws closer, people start realizing the difference between absurd claims and
ground reality. In a report published by Oxfam India dated January 24, 2018; a shocking
picture of Indian economy emerged as quoted:
73 per cent of the wealth generated last year (2017) went to the richest one per cent, while 67 crore
Indians who comprise the poorest half of the population saw one per cent increase in their wealth.
The current ruling coalition government run by National Democratic Alliance (NDA) and
led by Bharatiya Janata Party (BJP) has successfully imbibed the doctrines among Indian
population which are uncannily familiar to the ten principles laid out by Chomsky
contemplating an intimidating future with respect to Indian socio-economic and political-
legal scenarios in tandem.

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Further reading
Froyen, R.T. (2002), Macroeconomics: Theories and Policies, 7th ed., Pearson Education, NJ.
Oxfamindia (2019), “15 shocking facts about inequality in India”, available at: www.oxfamindia.org/
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Corresponding author
Debasish Roy can be contacted at: debasish2000@yahoo.com

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