Contextual Information:
In November 2016, the Indian government, in a sudden move, demonetised the INR 500 and INR 1000 banknotes, which accounted for over 86% of the currency in circulation. This decision was aimed at curbing black money, counterfeit currency, and corruption. However, it led to widespread cash shortages, impacting businesses, especially in the informal sector. The banking system was overwhelmed with people rushing to deposit old notes and withdraw new ones.
To counteract the negative short-term effects on the economy and to promote a digital economy, the Reserve Bank of India (RBI) and the government introduced various fiscal and monetary measures. On the fiscal front, the government launched incentives for digital transactions and provided tax rebates for small traders and businesses adopting digital payment methods. They also increased public expenditure on infrastructure and rural development to boost demand. On the monetary side, the RBI introduced a series of rate cuts to lower borrowing costs and incentivise spending. Additionally, special credit facilities were provided to farmers and SMEs to ease the liquidity crunch.
Table of Data:
Question for students:
Q1. Using an AS/AD diagram, explain the immediate impact of the demonetization on India’s economy.
Q2. Using an AS/AD diagram, illustrate the potential effect of the fiscal and monetary measures introduced by the RBI and the government post-demonetisation.
Q3. Using a money supply diagram, explain the short-term impact of demonetization on the liquidity in the Indian banking system.
Q4. Using information from the text/data and your knowledge of economics, evaluate the effectiveness of the RBI’s monetary policy measures in conjunction with the government’s fiscal measures post-demonetisation.