Benefit of Demonetisation uncertian says Nobel Laureate Economkst Paul Krugman

It is difficult to see major gains from India’s decision to drain out high-value banknotes from the economy, and the move might only force the corrupt to become more careful in the future, Nobel laureate and economist Paul Krugman said on Friday.

Instead, Krugman said, there will be significant-to-low costs to the so-called demonetisation, although he still saw India as a high-prospect economy.

Speaking at the 14th HT Leadership Summit, the 63-year-old economist said there was a good case to be made that high denomination banknotes didn’t serve a legitimate purpose.

“But that did not happen here. High-value notes are not being eliminated. This seems like a one-off attempt to flush out illicit cash,” Krugman said of the government decision to scrap 500-and 1,000-rupee bills to purge the economy of illicit “black money”.

The government has issued new 500-and 2000-rupee bills, and said it will later bring back new Rs1000 notes as well.

Krugman, who won the Nobel in 2008 for his work on global trade, said while he could understand the motivation for demonetisation, the move was “highly disruptive”.

But could such an exogenous shock transform behaviour? “I would be happy to be proven wrong. There could be some permanent change in behaviour. People will be more careful and sophisticated in laundering their money in the future,” he said.

Krugman said Indian economy, to him, looked like “China with a 15-20 year-old lag”.

“It has reserves of entrepreneurial rigour, reserves of educated people, wide use of English, and unlike China, it has not hit the demographic wall. It has a lot of potential.”

Watch | What Paul Krugman thinks is the Change India Needs

More on Invisible Bond Vigilantes 11-11

More on Invisible Bond Vigilantes

I argued yesterday that even if the heretofore invisible bond vigilantes materialize one of these days, their attack won’t have the effects the deficit hawks imagine. Because America has its own currency and a floating exchange rate, a loss of confidence would lead not to a contractionary rise in interest rates but to an expansionary fall in the dollar.

Here’s a case in point of people getting this wrong: the letter by 15 financial CEOs (pdf) urging a quick resolution of the fiscal cliff.

The letter is actually kind of amazing in a bad way even before we get to that issue: the CEOs apparently can’t or won’t get their heads around the fact that the fiscal cliff issue is all about doing too much, not too little, to reduce the deficit. Somehow, by the fourth paragraph concerns about a rise in taxes and a fall in spending depressing demand have turned into bond-vigilante fearmongering, with a warning that Moody’s might downgrade US bonds and send interest rates up. Guys, that’s not what we’re talking about here.

But even if we accept the bait-and-switch, from fiscal cliffery to fear of what will happen if we don’t have a Grand Bargain now now now; and even if we ignore the likely market reaction to a Moody’s downgrade, which would probably be a collective yawn (remember that absolutely nothing happened when S&P weighed in); the logic is still wrong. Even if Moody’s succeeded in scaring people, this would mean a weaker dollar rather than soaring rates — and this would be good, not bad, for the US economy.

It’s scary to think that such muddled thinking has dominated “serious” discussion.

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