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the effect depend on the marginal tax? Explain. * Q7. India's 2016 currency reforms. Please read the (short!) Economist article on India's 2016 currency reforms included with this week's materiall. (a) What was the stated purpose of the 2016 reforms? What did the government actually do? (b) Did the reforms have their intended effect? (c) What was the initial effect of the reforms on the price level and output? (d) How would you model the reforms in terms of the lS-LM model? Are the lS-LM predictions in line with the results discussed in part (c)? INDIA is not the first country to introduce abrupt, drastic reform of its currency. But the precedents-including Burma in 1987, the former Soviet Union in 1991 and North Korea in 2009-are not encouraging. Burma erupted in revolt, the Soviet Union disintegrated and North Koreans went hungry. All the more reason for Narendra Modi, India's prime minister, to prepare the ground before the surprise announcement on November 8th that he would withdraw the two highest- denomination banknotes (the 500-rupee and 1,000-rupee, worth about $7.30 and $14.60). Yet he did not and the result is a bungle that, even if it does achieve its stated aims, will cause unnecessary harm.Shops stopped accepting the old notes at once. Holders have until the end of the year to deposit them in banks or swap them, either for smaller-denomination notes or for new 500- and 2,000-rupee ones. That 86.4% by value of the cash in circulation is suddenly no longer legal tender has already caused predictable and needless hardship. It is too lateand politically unthinkableto start again (ses article). but Mr Modi should do more to limit the damage; and he should abandon the awed leadership style that caused the mess. _________;I Not the way to do it The plan has laudable aims. Its initial popularity was based on the idea that the greedy rich, with their ill-gotten "black money" stored in stacks of banknotes, will get their com eupp ance. Those who cannot justify the sources of their wealth will face punitive taxes. It also accords with Mr Modi's manifesto pledge to normalise India's black economy, estimated by the World Bank in zero to be worth about one-fth of ofcial GDP. The idea is that India will become more efcient, as more people and more money enter the banking system; counterfeit currency will become worthless; India's woeftu low tax base will expand; and government coffers will enjoy a windfall of cash expropriated from the corrupt. It is a pity, then, that Mr Modi's scheme to achieve these aims is so flawed. Banknotes are notjust a way for the rich to store their wealth: they are also how the unbanked survive. As so often, theburden of this reform has fallen most heavily on the poor (see article). Over four-fths of India's workers are in the "informal" sector, paid in cash. Untold numbers have been laid off because their employers cannot pay them. Tens of millions have queued for hours at cash machines and bank branch es, to get rid of the useless notes and get hold of some spending money. A new business has sprung up in laundering cash for a fee for those without the time or inclination to queue, or with more notes than they can account for. Cash is used for 98% by volume of all consumer transactions in India. With factories idle, small shops struggling and a shortage of cash to pay farmers for their produce, the economy is stuttering.There are reports that sales of farm staples have fallen by half and those of consumer durables by 70%. Guesses at the effect on national output vary wildly, but the rupee withdrawal could shave two percentage points off annual GDP growth (running at 7.1% in the three months to September}. With a bit of forethought, much of the mayhem could have been avoided. It turns out that the new notes are smaller and require all the country's ATMs to be recongured, which takes 45 days. Some zzbn notes are affected, but printing capacity is said by the previous nance minister to amount to only 3bn a month. So even if fewer notes are needed, because more money will be in banks, printing them will take some time. The banks were ill-prepared to handle about 8.5trn rupees in new deposits in the three weeks after demonetisation. After they used the deposits to buy bonds, lowering interest rates, the central bank had to order them to park the new money with it, in zero-interest accounts. If Mr Modi's plea for patience for a 50-day period until the end of the year looks optimistic, so does the promise of "the India of your dreams", purged of the corrupt and their loot. In India's black economy of undeclared, untaxed income, all sorts of transactions, from medical bills to house purchases, are sometimes settled with suitcase-loads of banknotes. Yet even ifthe hoarders will be wary of another conscation in the future, they will be tempted to make use of the new 2,ooo- rupee note just as they used the old 1,ooo-rupee one. Moreover, Mr Modi was wrong when he said that the rich now need sleeping pills, while the poor sleep peacefully. In past seizures of illegal wealth, only between 3.75% and 7.3% was found to be keptin cash. The sleepless are those who need cash to get by; the truly rich are laughing all the way to their ats in London. The punitive taxes levied on black money that is deposited will feel like flea-bites. As for the counterfeiters, most estimates of the value of fake rupees are in the tens of millions of dollars, out of stobn in circulation. Both for the sake of Indians and for his premiership, Mr Modi needs to mitigate some of the harm he has caused. He should nd ways of printing the new money more quickly. More important, he should also lengthen the period over which notes may be exchanged or deposited and allow the old notes to remain valid as payments for a range of goods and services (tax payments, say, would seem logical). Somewhat too sensational Much in India needs reformabolishing restrictive labour rules, for example. In the past such reform has often been stymied by a system that favours government by committee. Mr Modi has lurched to the other extreme. The perceived need for secrecy (to take cash-hoarders by surprise) fed into the innate sense he has of his own infallibility and his misplaced faith in his technocratic skills. By designing a scheme that was needlessly callous and which is becoming increasingly hllpsfww mmminwmcxpmxyjsedacukndermllmrhdiu-mncy-reorm-wu-bolched-in-exmlbn 336 07/03/2019 India's currency reform was botched in execution - India's policy unpopular, he has squandered political capital. In future he needs to consult more widely, centralise less decision-making in his own hands and acknowledge that not all criticism is partisan or special pleading from the corrupt rich. India, fortunately, is not North Korea, and is aware that leaders are fallible. Its federal, democratic system will give voters plenty of chances to let it be known how badly Mr Modi has messed up his rupee rescue. This article appeared in the Leaders section of the print edition under the headline "Modi's bungle"