The puzzle of the surge in currency-in-circulation

We are perhaps looking at a scenario where high unemployment and high inflation coexist, like in the 1970s

• June 04, 2021 5:45 AM

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

By Vighneswara Swamy & 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 that drives this high demand for money—income elasticity of demand being close to 1.5—is contrary to the prevailing economic situation marked by loss of jobs and reduced incomes, and slack in demand. The uncertainty-driven rise in currency in circulation—mostly for medical and other pandemic-induced emergencies like lockdowns—is a sign of temporary hoarding. There may also be cases of distress withdrawal or running down of savings to support families during this pandemic.

The demand for money has been increasing since demonetisation, more so over the last 14 months (during the pandemic), resulting in an increase in currency with the public to an all-time high of around Rs 29 trillion in May 2021. All efforts for a less-cash or cashless economy since demonetisation have gone for a toss as the currency in circulation is almost 50% more than the pre-demonetisation year.

RBI has been injecting money into the economy through unconventional measures such as long-term repo operations, securities acquisition plan, Rs 50,000 crore for health infrastructure, etc. On the other hand, people are stockpiling money both in cash and bank deposits as a cushion against uncertainty. As a consequence, a surge in money supply is building up in the economy. A recent data released by RBI suggests that broad money (a general measure of money supply in the economy) has grown 11.03% between April 2020 and April 2021, but the currency with the public grew 16.7% during the same period.

In a classical macroeconomic setting, the rise in currency in circulation—a major part of the high-powered money in India—should lead to a rise in price level. The wholesale year-on-year WPI in April was 10.49%, even as retail inflation was less than 5%. Although inflation is attributed to a rise in petroleum prices and shocks to supply chains, the rise in currency in circulation would have certainly played a part. Inflation would have been much higher without lower velocity of circulation of money due to lockdowns. However, once the severe movement restrictions across states are lifted, the huge liquidity in the market and the huge currency in circulation may lead to a higher price levels, particularly in the retail sector.

We are perhaps looking at a scenario where high unemployment and high inflation coexist, like in the 1970s. 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 jobless is bound to spike rapidly. This will cause a situation of joblessness coupled with excess money supply. According to the Phillips curve, low unemployment rates are associated with high inflation levels. So is the Phillips curve not working? Maybe the answer is ‘yes’. The unemployment rate is losing relevance as a means of gauging price levels during this uncertainty, which leads to panic-driven precautionary currency holding.

The decline in gross household savings—running down of savings due to loss of jobs or work—along with low or no incomes could potentially dent the future aggregate consumption that can jeopardise speedy revival of the economy. As the consumer market shrinks, investment revival looks more and more difficult. Investment slowdown in recent years is one of the main reasons for the fall in growth potential, and further fall in investors’ confidence due to low disposable incomes may not be helpful to arrest the decline in job creation and production.

Apart from price level and exchange rates, there are other macroeconomic implications of excess money on capital flows, bond market, etc. The central bank and the banking sector should take note of the rise in liquidity in the economy and ensure that there is no panic-driven hoarding. While the challenges posed by excess currency in circulation are many, the solution lies in how best the liquidity is used for generating demand, investment and growth impulses.