Demonetization and Velocity of Money – something overlooked by many

The CA from Gujarat, whose open letter to Kejriwal wherein he tried to explain to the ex-IRS officer and AAP Supremo the logic behind the Government’s introduction of Rs 2000 note, has now attempted to highlight an important impact of Demonetization: Velocity of Money-

The following Video shall reveal some very Interesting stuff about Money and give the readers some delightful food for thought…!

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Points to Ponder upon after Watching the above Video…

Money on the move has no fixed abode. From one wallet to another, from one shopper to the next, from one bank account to another, that is the life of money. But curiously, many of us want to cling on to every bit of money that we may have.

It is the greatest myth that Cash is like any other asset. In-fact, Cash was never meant to be kept as a commodity but it was always meant to be used as a “medium of exchange” for goods and services to be received. Have you ever come across of an investment in Cash kept in locker/home grow or provide returns ?

This is because Cash/Money in Bank has a peculiar feature:

A Single Note of Rs. 1000 is worth Rs. 10,00,000/- if it passes through 1000 citizens across the country in a year and is worth only Rs. 1000 if it is kept idle in a locker. This is called the Velocity of money. As the Velocity of money through banking channels increases, so will the tax collections from the said money. All the taxes which were earlier evaded by keeping the trail out of the economy, will now be recovered. And because money keeps travelling, taxes will be collected at each stage, thus giving a ripple effect to one act.

This is not the case for any other asset, lets say Machinery! If a single Machine is transferred through 12 people in a year, it will still give almost the same level of production.

The million dollar question then is “Will demonetisation help to increase the velocity of money ?”

“Velocity of money” is a term used to denote the number of times a unit of money in an economy changes hands during a certain period. By ‘money’, it does not mean the cash that we exchange in day-to-day transactions. Instead it is broad money where you also include bank deposits, post office savings and other bits and pieces of financial savings.

It is true that the economy may surely be benefited if the “Velocity of Money” increases and theoretically the move of demonetization and move towards cashless economy should help to increase the Velocity of Money but it cannot be proved with certainty because we never knew the velocity of money in parallel economy because those transactions were never captured in accounts or public records.

We do not really know the ‘rate of corruption’ in India or how fast corrupt Indians churn cash. Probably a black money holder would be interested in moving cash into consumption quite quickly, in which case this statistic would be higher. Or if black money holders are keener to stuff all their black cash under carpets or lockers and refrain from spending them too frequently, then it will be a smaller number. Thus we just don’t know what the macroeconomic effect of demonetization is going to be. It’s something we’ve just got to wait and see about.

Mathematically, Velocity of money is a derived statistics which can be arrived by dividing the value of GDP with the value of money in circulation. As an analogy, the sudden lowering of GDP due to demonetization can be offset if simultaneously we can increase the velocity of money.

However, the task of the Government as well as citizens is not going to be easy because as I said earlier , Cash leaves no trails. Hence it is in the interest of the Government as well as we common man to adopt to cashless means of doing business and encourage everyone to use banking route as much as possible.

 

This article first appeared here and has been enhanced with extra inputs.

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