Question

What are some of the arguments (by Indian policymakers and economists) in favor of demonetization? present the pros and the cons. Do you think these are short-run adjustments or a more serious problem impacting India's long run growth?

Answer 1

Answer.

In November 2016 , there was demonetisation of 500 and 1000 currency notes in India. The main aim of demonetisation was to curb black money , stop the financing to terrorism, eliminate corruption and make people to use digital transactions. This will help in formalising India’s informal sector. According to an Indian policy makers and economists demonetisation was a useful method to flush out black money and it will also induce public investment through revenue generated.

The demonetisation helps in reduction of interest rates in banks, As a result there is better circulation of money. That means with more circulation of money, government receives more taxes and generates revenues for public expenditure. Moreover it tends people to keep less cash in hands, so that there is increased savings. It helps in reducing the inflating price of assets like gold, real estate etc. It pushes economy to do less cash transactions and more of digital payments.

On the other hand, demonetisation involves huge costs in printing of new currency notes. In India, it had no impact on curbing black money , which was main objective of demonetisation. It was argued that black money is held in materialistic things such as in form of gold and real estate. Moreover the immediate impact of it is on small scale industries , poor and middle class families and informal sectors as their earnings are lowered, face losses and reduced consumption demand by households.

These are long run adjustments by government for higher growth and increase revenues if implemented in better way.  In short run, GDP growth will slow down as in India many people are employed in unorganised sector and belong to middle class families. The consumption demand will decrease, which hurts growth of an economy. Money supply reduces in an economy unless new currency notes are circulated widely. Farmers , small traders, households, daily wage earners will face problems due to less liquidity of cash. However, in long run government revenues will increase , such that there will be more public expenditure and increase in employment. Moreover, increased demand for digital payments and boost higher growth in India. Thus, improving fiscal situation of the country.