Demonetization
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Definition of Demonetization:
Demonetization occurs when a government declares a unit of currency is no longer legal tender. For example, if the US government declared that the twenty-dollar bill is no longer acceptable as money, the twenty-dollar bill would be demonetized.
Detailed Explanation:
Most countries have legal tender, meaning their currency has a value established by the government, even though the physical material—paper or coins—is worth far less than the currency’s declared value. Occasionally, governments remove certain currencies from circulation and declare them no longer acceptable as money. This process, known as demonetization, is undertaken for various reasons.
For example, countries in the European Union demonetized their national currencies when they adopted the euro as their shared currency on January 1, 1999. Citizens of the eleven original member countries were given a transition period to exchange their currencies, ensuring a smooth shift. The goal was to boost trade within the European Union by eliminating the uncertainty and risks associated with fluctuating exchange rates.
Another example occurred in Zimbabwe, where inflation reached an unimaginable 231,000,000 percent in 2008. To put this into perspective, a candy bar costing $1.00 in 2007 would have cost $2,310,000 just a year later. As the currency lost all value, people abandoned money altogether, turning to bartering instead. When money was used, the American dollar became the preferred currency. Fortunately, Zimbabwe has since brought inflation under control and is recovering from the devastation caused by hyperinflation. On June 15, 2015, the Zimbabwean government officially demonetized the Zimbabwe dollar. For more details, refer to Jonathan Garber’s article in
Business Insider, published on June 11, 2015.
Demonetization in India
On November 8, 2016, Prime Minister Narendra Modi made a surprising announcement, declaring the immediate demonetization of India’s 500 and 1,000 rupee notes. These notes accounted for 86 percent of the currency in a heavily cash-reliant economy. Citizens were instructed to redeem or deposit their old notes at banks.
The Prime Minister’s objectives were to increase tax revenue, combat crime, and reduce corruption. India’s underground economy—estimated to be equivalent to 50 percent of the country’s gross domestic product—relies heavily on cash transactions to evade taxes. Tax revenues have increased since the demonetization program’s implementation, indicating some success in formalizing the economy.
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