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• Motivation
In last year, Demonetization was a major economic incident and a bold move by the
government. As soon as the PM announced about demonetization, a debate started in the
whole country. On the news channel, at the offices, everywhere everyone wanted to
understand the effects of demonetization as it was not so obvious. I was also one of them who
were interested, curious and excited about the recent event. I thought that I should understand
the economic point of view of such a big event as economics student. All these things inspired
me to dig into this topic.
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This study would help in understanding the cost benefit analysis of demonetization in India.
This study would also help in finding out the sectors that are affected due to demonetization
and appropriate actions could be taken by the government by modifying the policies
accordingly. This study also shows the way to government to take the decision by observing the
objectives and the results of demonetization done in many countries in past.
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Australia 1996 To the curb black money crisis and Success
improve security features on the
notes
Britain 1971 To bring uniformity in currency failed in other countries
except Britain
Zaire 1990 A plan to withdraw obsolescent Failed
currency from the system
USA 1969 Due to black money Success
By investigating the table, we can observe that most of the countries that have done the
demonetization, have failed miserably in doing that. The main reasons behind the success could
be the behavior of Indians to find a way to show patriotism and the belief of Indian people in
their strong government. Other than this observation, we can see in the table this table.
GDP Growth Rate in Pre, During and Post Demonetization Periods
10
0
GDP growth
Nigeria Ghana Soviet Union Zaire Myanmar Australia United States Britain
-5 of America
-10
-15
-20
Country & time periods
Pre During Post
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economy collapsed at that time but after the demonetization they grew at higher rate. Other
than this Australia was pretty stagnant in terms of growth rate in pre-and post-demonetization
period. United States and Britain felt a slowdown in the growth rate during demonetization
year but after they grew at higher rate. Many other countries also done the demonetization
when they had high negative growth rates in the following years, so they couldn’t succeed and
their economy collapsed. By this we can understand that it is pretty hard to sustain the growth,
and we should be aware and alert of that fact and should take appropriate actions, otherwise
the story would remain the same for us also.
QUARTERLY ESTIMATES OF GROSS VALUE ADDED AT BASIC PRICE IN 2016 (Base: 2011-12)
8000
7000
(Rupees in Billion)
6000
5000
4000
3000
2000
1000
0
Agriculture, Mining & Manufacturing Electricity, Gas, Construction Trade, Hotels, Financial, Real Public
Forestry and Quarrying Water Supply & Transport, Estate and Administration,
Fishing Other Utility Communication Professional Defence and
and Services Services Other Services
Related to
Broadcasting
Industry
Q1 Q2 Q3
Note: Q1, Q2, Q3 & Q4 denote - April to June, July to September, October to December and January to March
quarters, respectively.
Source: Central Statistics Office (CSO).
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Manufacturing Sector
Manufacturing sector histograms in the above set of graphs shows that manufacturing sector
has come down in the Q3. It is including the formal sector only, that’s why it is only a small
dump. Otherwise, it could have been a large dump because of a huge effect on the informal
sector in manufacturing industry. At the time of demonetization, everyone was getting small
amount of cash that was only good to make the daily expenses of a person and his /her family.
Same was the case with the people that were running many manufacturing firms. They didn’t
have enough cash to pay their employers on daily basis. The supply of workers went down
because they were not getting new notes to buy something by doing the work at firms. Some
cases were seen those days of the firm masters giving the employers the old notes. That lack of
the labor, lead to less production in manufacturing sector in Quarter 3.
Real Estate
By the graphs, we can see that In Financial, Real Estate and Professional services, there is a
significant dump in the quarter 3. We can understand this scenario by observing the basic
characteristics of these sectors. We know that in the real estate sector, most of the transactions
of even very big deals are done through the cash. People don’t prefer the online transactions in
these cases due to the fear of various duties and taxes on big transaction to buy and sell
properties. When the demonetization was done, people had lesser currency with them than
that of normal days to do the transactions. A large chunk of black money is invested in the real
estate, so real estate people had more currency than that of according to their real income. The
people who had sold the property in recent time, had enough cash but they could not tell the
source of that. That large supply of money was adjusted somehow by these people to change
with the new notes and in this process, large chunk of currency went out of the market that is
the essential lubricant to run the real estate smoothly. In this way, the loss was accounted due
to very less activities. Now, we can understand that, Real Estate is most reactive sector towards
economic policy changes like changing in Interest rate, Demonetization, Tax Reforms, Shrinking
Stock Markets etc. Therefore, we can see above in the histogram that Real Estate market fell
down in Q3 due to shorting of cash.
Construction Trade, hotel, Transport Sector, Broadcasting Related services, Mining and
Quarrying sectors’ output not changed in Quarter 3 because in these sectors a very few
transactions are made in cash.
Agricultural and Forestry Sector
Agricultural output is not seen immediately as crop take time in growing. So, the data shown in
the graph actually representing the output of the previous quarter. So, we would be able to see
the effect of demonetization on agriculture only after the results are out for the next quarter.
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• Macroeconomic View
We should try to understand that what happened in the economy due to the chaos created in
the economy due to demonetization. Baumol (1952) tried to understand the transaction
demand for money dependent on the interest rates and the pattern of the expenses procedure.
We generally have two procedures either the receipts follow disbursements or the
disbursements follow receipts. By taking both accounts when we perform the calculations then
we find out that demand for the cash is not proportional to the value of transactions.
Here is simplified equation of Baumol’s model
𝒌
∆𝑻 = 𝟐 ∗ 𝒌 ∗ ∆𝑪 + ∗ ∆𝑪𝟐
𝑪
Where T is value of total transaction, C is amount of cash withdrawal and
k is transaction velocity of cash 𝒌 = 𝑻/𝑪
If our transactions go up by a multiplier two than we don’t need double cash but we need much
lesser than that. From a different point of view, if we think that our total transactions go down
by a multiplier half, our demand for the money has not come down to half of the previous one,
we still need money more than half of the previous demand. This theory also has an implication
that if a large area has the same currency notes as medium of transaction, then they need
lesser money supply overall than the case of having different currency for the different regions.
That implies that if the whole world has the same currency then the world would need lesser
money supply than it has now. In perspective of India’s demonetization, we can say that this
concept was increasing the chaos because when the transactions were going down due to lack
of money supply, still the need of money supply was not going proportionately down so we
could transact even less than what was generally done with the money we had in the market at
that time. We can understand this thing by the example that let’s say we had 10 percent of the
money supply than we generally have in our country, then we could do far less transactions
than the 10 percent of the total transactions we generally could do with our money supply.
By the model, we can also observe that the value people want to draw in one go is always
positively related with the broker’s fee. Baumol explained that the broker’s fee is not only the
charges we have to give to the bank or the other institution to withdraw the money. As there
were many long lines outside the banks during the demonetization period, obviously, the
broker’s fee had increased for all the people, so everyone wanted to take away a big chunk of
money in one go therefore there was a need to have an upper limit on the withdrawal limit and
that was also done by the government. In a way, this thing also helped in pumping the money
again in the economy because the people were withdrawing the money at the maximum limit.
As the broker’s fee was high, everyone wanted to withdraw high if they are going to withdraw
but at the same time everyone wanted to avoid the withdrawing if possible. Other than this,
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interest rates were reduced a bit to encourage the money supply in the country because lower
interest rate leads to a high consumption that was needed at that time to boost the economy.
• Conclusion
Initially Govt’s Objective was to curb black money but if we look at the figure, 97% of ₹500 and
₹1000 rupees’ banknotes were deposited in banks and only 3% (.43 trillion rupees) black money
scraped as undeclared income hence we can say a less part of Black Money is in cash so this
action isn’t effective to curb black money. However, Tax GDP ratio will increase in future. Due
to demonetization counterfeiting currency market offhand shut down for a while but they have
capability to create new notes’ duplicate so we can say in short run their activity will be
slowdown but in long run they can rebuilt their market and also it is easy to handle 2000 rupees
notes instead of 1000 rupees notes in briefcase to giving bribe. In this study, we have found
some important points about the short-term effects of demonetization as well as about the
long-term effects by observing the previous cases of demonetization in other countries. We
have to be alert and thoughtful to sustain our growth because many countries which have done
demonetizations could not sustain the same. In short run, almost all the sector in the Indian
economy have been affected negatively due to shorting of cash. However, in long-run Informal
Economy would be formalize. So, government have to focus on informal economy and need to
make appropriate policies for them. Other than this, we have got the point by using the
Baumol’s model in this case that the transactions were more difficult to make than it could be
simply estimated by the ratio of money supply in demonetization period to the normal period’s
money supply.
Money supply reduction results to fall in interest rate and accessibility of loan will be easier as
interest rate decrease. It will be helpful to new entrepreneur for their startup.
After demonetization, Indian economy got the momentum towards Case less economy. Long-
term effect of demonetization couldn’t identify yet due to less availability of information set.
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• Data Source
i) Data on GDP Growth of various countries is taken from World Bank website. We use three
Conjugative years’ GDP to analyze the demonetization impact on their economy.
ii) Various Sectors’ Quarterly Gross value added output data at basic price in 2016 (Base: 2011-
12) is taken from RBI’s official website (Reserve Bank of India).
iii) Data on Demonetization in various countries is taken from various website
-Economics Times’s website
- A word to the world’s website
-naukrinama’s website
• References
Dipankar Dasgupta. (2016, December 17). Theoretical Analysis of Demonetisation. Economic
and Political Weekly, Vol ll No. 51.
Vineet Kohli, R Ramakumar. (2017, January 4). Economic Rationale of Demonetisation.
Economic and Political Weekly, Vol. 51, Issue No. 53.
Kobad Ghandy. (2016, December 10). Demonetisation One Step Forward, Two Steps Back.
Economic and Political Weekly, Vol ll No. 50.
Arun Kumar. (2017, January 7). Economic Consequences of Demonetisation Money Supply and
Economic Structure. Economic and Political Weekly, Vol lll No. 1.
Parag Waknis. (2017, February 27). Demonetisation through Segmented Markets: Some
Theoretical Perspectives, Economic and Political Weekly, Vol. 52, Issue No. 9.
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