Cash Rush: Note slash and black economy

While demonetisation might have an impact upon the ‘stock’, it will not have much effect on the ‘flow’ of black money.

Written by Adrija Roychowdhury | Updated: November 17, 2016 11:46 am

 

demonetisation, demonetisation details, demonetisation policy, demonetisation news, RS 1000, Rs 500, RS 1000 note, Rs 500 note, 500 note, 2000 note Demonetisation will lead to lowering of demand for goods from holders of black liquidity, thereby cutting inflation, and so increasing confidence in the government.

Two years before the Morarji Desai government scrapped high-denomination notes, two Delhi School of Economics economists- K. Sundaram and V. Pandit, published a paper analysing the impact of demonetisation on black economy.  Some key points they made in the paper that appeared in the Indian Economic Review on October 1976 are as follows:

Acquiring black money: It arises from the evasion of both direct and indirect taxes. The difference between ‘stock’ and ‘flow’ of black money is crucial to understand the working of a black economy.

Black incomes are more common in countries where the economy depends on planning, and particularly where significant price controls and quotas are placed on commodities. The margin between price controls and market-clearing prices form the major part of black income. India is a perfect example.

Saving black money: Most commonly, it takes the form of cash, gold, and inventories of goods. Black income can also be utilised in capital equipment by understating the value of the equipment and then paying the difference between the commodity’s true value and declared value through black savings. A majority of black savings are spent in the unorganised sector, giving rise to a further “flow of structural black income”.

Demonetisation to deal with black income: It is advocated on the assumption that holders of black liquidity assets would want to present only a small portion of their savings for conversion. The success of this policy depends on the amount of black savings has been held in the denomination of demonetised currency. If a significant part is held as gold etc., it will not have any effect.

The policy will not be any good if it is anticipated in advance, in which case conversions of liquid assets to other commodities such as gold would be made. In order to be successful, demonetisation has to be accompanied with a ban on trading in all these assets.

While demonetisation might have an impact upon the ‘stock’, it will not have much effect on the ‘flow’ of black money. However, it will lead to lowering of demand for goods from holders of black liquidity, thereby cutting inflation, and so increasing confidence in the government.

 

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  1. M
    Munukutla Venkateswararao
    Nov 19, 2016 at 5:06 am
    What this writer wants to convey.?I Know the domonitisation of 1978 and its effect on public..Nobody knew how a 10000,5000 and 10000/ looked.At that time I was a clerk in Statebank of India It is a Dist.head quarters branch.We had two branches of our own and some 14 Other banks.Our branch only received the demonitised notes and none other.we received some 30 pieces of ₹1000/ note denomination.we did not receive any other denomination.The original stock itself is very small.The opening stock was one section (100pieces ) of ₹1000/and some less than 100/ in case of ₹5000/denomination.and only one piece of ₹10000/note.So with demonitisation we added 30 Pieces of ₹1000/ to our old stock.At that time clerks were not allowed to enter the cash vault.On special request our the then head cashier allowed us in to the vault and showed those notes.I was one of the few who had seen the notes at that time.How can you compare that demonitisation with this.?As the chairperson rightly pointed out this had a very significant impact on the parallel economy and formal channels
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