Strategic Consumer Behavior in Response to Government Policy

Abstract

This paper studies consumer behavior in the retail setting in response to a government policy aimed at economic transparency, and quantifies its unintended consequences for retailers vis-a-vis the policy goal. Using transaction-level data from a large retail chain in India, we document consumer strategies, that leverage the presence retailers, to avoid costs associated with the country's currency reform policy. We observe both an increase in returns of cash-purchased items that were bought before demonetization (strategic returns) and a spike in final cash purchases with soon-to-be-illegal notes (strategic purchases). Both practices serve consumer incentives to either receive legal notes from the retailer or to avoid depositing cash to formal bank accounts. Our analysis suggests that strategic consumers benefited the retail chain overall while partly hindering the intended effect of the policy, leaving more than 100 billion INR (1.5 billion USD) of demonetized notes outside the formal tax network. Our findings (i) offer implications for policy makers and retailers by quantifying the economic significance of strategic consumer practices, and (ii) document a new role of the retail industry - of absorbing and responding to macro shocks.