Research Discussion Paper – RDP 2015-05 The Social Costs of Currency Counterfeiting Abstract

Currency counterfeiting is costly for society. Law enforcement agencies allocate substantial resources to deter, detect and prosecute counterfeiting operations, households and businesses suffer a direct loss to counterfeiters and undertake costly prevention measures, and central banks spend considerable resources upgrading and improving the security of banknotes. Without these prevention efforts, there is a risk that the public could lose confidence in the currency and reduce its use relative to more costly payment alternatives.

This paper examines the social costs of counterfeiting in Australia. First, we provide some statistics on counterfeiting domestically and compare Australia's experience with some other economies internationally. We find that the direct costs of counterfeiting in Australia are relatively low when compared with other economies, but that there can be substantial deadweight costs associated with prevention efforts and losses of confidence in the currency.

Second, we focus on quantifying the effect of a loss of confidence in the currency. To do this, we estimate a structural vector autoregression using the Australian data. In response to a positive one standard deviation counterfeiting shock, the demand for banknotes declines and the use of credit cards and bank deposits increase. These results are consistent with the presence of substitution effects. Using a scenario to quantify the real resource costs associated with these substitution effects, our estimates suggest that an increase in counterfeiting of around A$140,000, spread over ten years, leads to a total increase in social costs of A$7.0 million. Although the statistical uncertainty implied in the model and scenario estimates is large, the results suggest that there are significant pay-offs from efforts to prevent and deter counterfeiting activity in Australia.

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