Efficient Demonetization

Traditional models of money assume that the marginal social cost of printing fiat currency is zero, justifying the optimality of the Friedman rule. However, in an environment where the degree of hidden income is alleviated by the dearth of cash, demonetization could be efficient. I isolate conditions under which state-contingent transfer limits are monotonic in reported endowments and promised values. A model calibrated to the Indian income process reveals that long-run gains in the surplus of the central bank upon switching to a state-contingent monetary policy from a non state-contingent one are 28.48% of aggregate income.