Too Much Rhetoric, Too Little Substance

( Views are strictly personal. No offence.)

The purpose of this post is to consider to what extent the excess money (cash) flow has raised the price level, ambiguity in transactions and corruption and how current demonetization can bring about the effective solution. Before the actual analysis has been made, it is fair to tell you that no precise instrument (rather, we say procedure) has been made as yet to stop corruption and inflation by demonetization. There are several ways of demonetization. I am not going to tell all the details. Moreover excess liquidity does not stay in liquid form. More often then not, the excess liquidity, we consider, equal to the more abused term "black money" and analysis says that this black money may assume the form of real estates, stocks, bonds and gold.

The relationship between inflation and monetary policy can probably be discussed most conveniently by referring to the classical ‘equation of exchange’, developed by Irving Fisher in 1911. i.e. MV=PT. Money supply and velocity are the two main components which changes over the period of time.(or the stocks manipulation  ) According to so called "Liberal Monetarists" (Eg. Milton Friedman) money and velocity only changes the equation which in turn changes the economy. If we go with this the main reason behind increasing corruption is the money flow with more velocity i.e. excess liquidity. Some of you may argue that increases in the money supply will tend to be offset by exactly proportional declines in velocity — thus, ‘money does not matter’, the strict Keynesian view. For some, velocity remains constant. But the main problem is between that. To control the flow and velocity, many monetarists suggested to use demonetization as a tool to curb black money.

But it is not the absolute solution. There are two ways to bring about demonetization. One, demonitizing lower currencies (eg. 25 paise, 50 paise coins), two demonitizing higher currencies (500, 1000 rupees notes). First way is strictly limited to control the inflation by maintaining the money circulation and encouraging consumption(increases demand). Second one, sometimes led you to inflate the prices. Because it makes you apathetic to spend whatever you have in cash. This in turn decreses circulation (that is what our Govt wants by this new decision of demonetization) and deteriorate demands too, which is detrimental to the economy. It stimulates the prices to rise higher and higher like 'up above the world so high'. But there are no diamonds.

Nevertheless decision is a good one. RBI has to work out. let's hope for the best.