The puzzle of the soaring currency in circulation

There may also be cases of distress withdrawal or depletion of savings to support families during this pandemic.

By Vighneswara Swamy and Pravakar Sahoo

The rise in currency in circulation or with the public when the economy is experiencing both supply and demand shocks is puzzling. The precautionary motive behind this strong demand for money – the income elasticity of demand being close to 1.5 – is contrary to the economic situation marked by the loss of jobs and the fall in income, and the weakness of the economy. Requirement. The uncertainty-induced increase in currency in circulation – primarily for medical emergencies and other pandemic-induced emergencies like lockdowns – is a sign of temporary accumulation. There may also be cases of distress withdrawal or depletion of savings to support families during this pandemic.

The demand for silver has increased since demonetization, more so in the past 14 months (during the pandemic), causing the currency with the public to rise to a record high of around Rs 29 trillion in May 2021. All efforts for a less cash or cashless economy since demonetization, as the currency in circulation is almost 50% more than the year before demonetization.

The RBI injected money into the economy through unconventional measures such as long term repo transactions, a securities acquisition plan, Rs 50,000 crore for health infrastructure, etc. On the other hand, people store money both in cash and in bank deposits as a cushion. against uncertainty. As a result, an increase in the money supply accumulates in the economy. Recent data released by RBI suggests that broad money (a general measure of money supply in the economy) increased by 11.03% between April 2020 and April 2021, but currency with the public increased by 16 , 7% over the same period.

In a classic macroeconomic framework, the rise in the currency in circulation – a significant part of the major currency in India – should lead to a rise in the price level. The year-on-year wholesale WPI in April was 10.49%, even as retail inflation was below 5%. Although inflation is attributed to rising oil prices and supply chain shocks, the rise in the currency in circulation would certainly have played a role. Inflation would have been much higher without the slower speed of money flow due to the lockdowns. However, once the severe restrictions on interstate movement are lifted, the huge market liquidity and huge currency in circulation could drive prices up, especially in the retail sector.

We are perhaps faced with a scenario where high unemployment and high inflation coexist, as in the 1970s. The CMIE reports that the unemployment rate in April 2021 was 7.97% (urban 9.78% and rural 7 , 1%). However, as most states announced severe restrictions / lockdowns in May, the number of unemployed is expected to rise rapidly. This will lead to a situation of unemployment coupled with a surplus money supply. According to the Phillips curve, low unemployment rates are associated with high inflation levels. So, doesn’t the Phillips curve work? Maybe the answer is “yes”. The unemployment rate loses its relevance as a means of gauging price levels during this uncertainty, leading to panic-triggered preventive currency holding.

Declining gross household savings – the depletion of savings due to loss of jobs or work – along with low or no income could potentially hurt future aggregate consumption, which can jeopardize the recovery. fast economy. As the consumer market shrinks, relaunching investment promises to be more and more difficult. The slowdown in investment in recent years is one of the main reasons for the decline in growth potential, and a further decline in investor confidence due to low disposable income may not help halt the decline in job creation and production.

Besides the price level and exchange rates, there are other macroeconomic implications of excess money on capital flows, the bond market, etc. The central bank and the banking sector must take note of the increase in liquidity in the economy and ensure that there is no panic. palisade driven. While the challenges posed by excess currency in circulation are many, the solution lies in how best to use liquidity to generate demand, investment and growth impulses.

Swamy is a professor, ICFAI Business School, Hyderabad; Sahoo is professor, Institute of Economic Growth, Delhi

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