Functions of Money

Introduction: The Need for Money

In any economy where individuals specialize in producing certain goods and services, a system of exchange is necessary for them to acquire the things they do not produce themselves. In the absence of a universally accepted medium of exchange, societies rely on a barter system.

Barter is the direct exchange of goods and services for other goods and services. For example, a farmer trades a bag of rice for a pair of shoes from a shoemaker. While simple in concept, this system is highly inefficient in a complex economy.

Drawbacks of the Barter System

The barter system suffers from several major drawbacks that hinder economic activity:

1. Lack of Double Coincidence of Wants: This is the most significant hurdle. A successful transaction requires that each party has what the other wants and wants what the other has, at the same time and place. For instance, a person with a surplus of rice wanting to trade for clothing must find someone with a surplus of clothing who desires rice. The time and effort spent searching for a suitable trading partner, known as transaction costs, can be prohibitively high.
2. Absence of a Common Measure of Value: In a barter economy, there is no standard unit to express the value of goods. Every good must be valued in terms of every other good. For example, how many pairs of shoes is one cow worth? How many kilograms of wheat is one pot worth? With thousands of goods, the number of exchange ratios would be astronomical, making trade cumbersome and rational economic calculation impossible.
3. Difficulty in Making Deferred Payments: Many economic transactions involve future payments (contracts or loans). In a barter system, it is difficult to make such agreements because the value of the commodities to be repaid in the future (like grains or livestock) can fluctuate significantly. There is also a risk of disputes over the quality of the goods being repaid.
4. Problem of Storing Wealth: It is difficult to store wealth in a barter system. Most goods, like grains, fruits, and cattle, are perishable, expensive to store, and can lose value over time. Holding wealth in the form of such goods is impractical and risky.

To overcome these inefficiencies and facilitate economic growth, societies developed money. Money is defined as anything that is generally accepted as a medium of exchange, a unit of account, and a store of value.

The Main Functions of Money

Money performs three primary and interconnected functions that directly address the problems of the barter system.

1. Medium of Exchange

This is the central function of money. It acts as an intermediary in the exchange of goods and services, breaking a single barter transaction into two separate transactions: a sale and a purchase. An individual can sell their goods for money and then use that money to buy the goods they need from someone else. This completely eliminates the need for a double coincidence of wants.

By significantly reducing transaction costs, money promotes specialization and division of labour. Individuals can specialize in what they do best, confident that they can sell their output for money and use that money to satisfy their diverse needs. This leads to increased productivity and overall economic prosperity.

For something to function effectively as money, it should possess certain characteristics: Durability, Portability, Divisibility, Uniformity, Limited Supply, and Acceptability.

2. Unit of Account

Money serves as a common yardstick for measuring and expressing the value of all goods and services. Just as we use kilograms to measure weight and meters to measure distance, we use money (e.g., rupees) to measure economic value. This function solves the "absence of a common measure of value" problem of the barter system.

• Standardized Pricing: It provides a consistent way to state prices. A pen costs $\text{₹} \ 10$, and a book costs $\text{₹} \ 100$. This is far simpler than stating the price of a book as 10 pens, 20 pencils, or 0.05 of a shirt.
• Easy Comparison: It allows for the easy comparison of the relative values (or opportunity costs) of different goods and services. One can immediately see that the book is ten times more valuable than the pen. This facilitates rational decision-making by consumers and producers.
• Simplified Accounting: It is essential for business and government accounting. Profits, losses, revenues, costs, and national income are all calculated and expressed in monetary units, which would be impossible in a barter economy.

This function also allows us to understand the concept of purchasing power. If the general price level in an economy doubles, the value or purchasing power of one rupee is halved, meaning it can now purchase only half the amount of goods and services it could before.

3. Store of Value

Money acts as a means of holding wealth and transferring purchasing power from the present to the future. Unlike perishable goods in a barter system, money is durable and its storage costs are negligible. It is the most liquid of all assets.

Liquidity refers to the ease and speed with which an asset can be converted into a medium of exchange without significant loss of value. Money is perfectly liquid by definition. Other assets like land, buildings, or bonds must first be sold (converted to money) before they can be used to buy other things, a process which takes time and may involve costs.

However, money is not a perfect store of value. During periods of inflation (a rising price level), the purchasing power of money erodes. If inflation is 10% per year, then $\text{₹} \ 100$ held as cash will only be able to buy $\text{₹} \ 90$ worth of goods at the end of the year. In such situations, other assets like gold, real estate, or bonds may serve as a better store of value, although they lack the perfect liquidity of money.

Demand for Money and Supply of Money

Demand for Money (Liquidity Preference)

The demand for money does not mean how much money a person wants to earn. Instead, it refers to the decision by individuals, firms, or the government to hold a part of their wealth in the form of the most liquid asset—money (cash or chequable bank deposits). This desire to hold liquid assets is termed liquidity preference by economist John Maynard Keynes.

Holding money involves an opportunity cost. By holding cash, one forgoes the interest or return that could have been earned by investing that money in other assets like bonds, stocks, or fixed deposits. Therefore, the demand for money is a trade-off between the convenience and security of liquidity and the interest that is lost. The motives for this preference are broadly categorized into two types.

1. The Transaction Motive

This is the most straightforward reason for holding money. People need money to bridge the time gap between the receipt of income and the timing of their expenditures. Economic agents (households and firms) hold cash to carry out their planned, day-to-day transactions.

• Dependence on Transactions Volume: The amount of money required for transactions is directly proportional to the total value of transactions in an economy over a period.
• Dependence on Income: Since the total value of transactions is closely linked to the national income, the transaction demand for money is positively related to the level of nominal income. A rise in income and prices leads to a rise in the value of transactions, thus increasing the demand for money.

This relationship is formalized as:

$M_T^d = k \cdot P \cdot Y$

Where:

• $M_T^d$ is the transaction demand for money.
• $P \cdot Y$ is the nominal Gross Domestic Product (GDP), where $P$ is the price level and $Y$ is the real GDP.
• $k$ is a positive constant representing the fraction of nominal income that people desire to hold as cash for transactions. The value of $k$ depends on institutional factors like the frequency of income payments and spending habits.

The inverse of $k$ ($1/k$) is known as the velocity of circulation of money (v), which represents the average number of times a unit of money changes hands during a period. Thus, the equation can be written as $M_T^d = (1/v)PY$, or $v \cdot M_T^d = PY$.

2. The Speculative Motive

This motive relates to holding money as a financial asset to speculate on the future movements of the market interest rate and, consequently, the prices of other financial assets like bonds.

Inverse Relationship between Bond Price and Interest Rate: A bond is a debt instrument that promises a fixed stream of future payments (coupons) and repayment of the principal amount at maturity. The market price of an existing bond is inversely related to the prevailing market rate of interest.

Answer:

This relationship is crucial for the speculative motive:

• When the interest rate is high, people expect it to fall in the future. A future fall in interest rates would lead to a rise in bond prices, resulting in a capital gain. Therefore, people will convert their money into bonds, and the speculative demand for money will be low.
• When the interest rate is low, people expect it to rise. A future rise in interest rates would lead to a fall in bond prices, resulting in a capital loss. To avoid this loss, people will sell their bonds and hold cash. Thus, the speculative demand for money will be high.

Therefore, the speculative demand for money ($M_S^d$) is inversely related to the market rate of interest ($r$).

At a very low interest rate, the demand curve can become perfectly elastic. This situation is called a liquidity trap, where everyone expects the interest rate to rise, and hence nobody wants to hold bonds. Any additional money supply is simply held as cash.

The total demand for money ($M^d$) in an economy is the sum of transaction and speculative demands:

$M^d = M_T^d + M_S^d = kPY + f(r)$

Supply of Money

The supply of money is a stock variable, meaning it is the total stock of money in circulation among the public at a particular point in time. In a modern economy, this supply is created and managed by a system comprising the central bank and the commercial banking system.

1. The Central Bank

The central bank is the apex institution of a country's monetary and financial system. In India, the Reserve Bank of India (RBI) performs this role. It has several key functions that are central to the money supply:

• Bank of Issue (Issuing Currency): The RBI has the sole authority to issue currency notes in India (except for the one-rupee note and coins, which are issued by the Ministry of Finance but circulated by the RBI). This ensures uniformity and control over the currency.
• Controller of Money Supply and Credit: This is a crucial function. The RBI uses various monetary policy tools (discussed in a later section) to regulate the amount of money and credit in the economy to achieve objectives like price stability and economic growth.
• Banker, Agent, and Advisor to the Government: The RBI maintains the government's accounts, makes payments on its behalf, manages public debt, and advises the government on monetary and financial matters.
• Banker's Bank and Supervisor: The RBI acts as a bank for the commercial banks. It holds part of their reserves, settles inter-bank transactions, and supervises and regulates their operations to ensure the stability of the banking system.
• Lender of Last Resort: When a commercial bank faces a financial crisis and cannot get funds from anywhere else, it can approach the RBI for a loan. This function prevents bank failures and protects the financial system from collapse.

The currency issued by the central bank that is held by the public and by the commercial banks is called High-Powered Money ($H$) or the monetary base. It is termed "high-powered" because the reserves component of this money ($H = \text{Currency with public} + \text{Reserves with banks}$) serves as the basis for the creation of a much larger amount of money by commercial banks through the credit creation process.

2. Commercial Banks

Commercial banks are the other crucial part of the money supply system. They act as financial intermediaries, connecting savers and borrowers. Their primary functions are:

• Accepting Deposits: They accept deposits from the public, which can be in the form of demand deposits (like current and savings accounts) or time deposits (like fixed deposits).
• Advancing Loans: They provide loans and advances to individuals and businesses for various purposes. It is this lending activity that leads to the creation of credit or money.

Banks earn profit through the "spread," which is the difference between the interest rate they charge on loans and the interest rate they pay on deposits. Their role in lending out deposits is what drives the money multiplier effect and the creation of the broader money supply.

Money Creation by the Banking System

One of the most significant functions of commercial banks is their ability to create money. It is important to understand that banks do not create money by printing currency notes; that is the exclusive right of the central bank. Instead, commercial banks create money in the form of demand deposits, which are a major component of the money supply. This process of creating demand deposits through lending is known as credit creation.

The entire process is based on the system of fractional reserve banking. This system relies on two key assumptions:

1. Banks are legally required to hold only a fraction of their total deposits as reserves (cash) and can lend out the rest.
2. Based on historical experience, banks know that not all depositors will show up to withdraw their entire funds at the same time on any given day.

The Process of Credit Creation

The process of credit creation is a chain reaction that begins with an initial deposit and continues through multiple rounds of lending. Let's understand this with a detailed example.

Initial State: Balance Sheet of a Fictional Bank

Let's assume there is only one bank in the economy for simplicity. A balance sheet is a statement of a firm's assets (what it owns) and liabilities (what it owes). For a bank, deposits are liabilities (as they are owed to the depositors), while reserves and loans are assets (reserves are claims on the central bank, and loans are claims on borrowers).

Suppose a person, let's say Leela, makes an initial deposit of $\text{₹} \ 100$ into the bank. The bank's initial balance sheet looks like this:

At this point, the total money supply in the economy is $\text{₹} \ 100$.

The Lending Process

Now, let's assume the central bank has set the Cash Reserve Ratio (CRR) at 20%. This means the bank must keep 20% of its deposits as reserves and is free to lend the rest.

1. Round 1: The bank is required to keep $20\%$ of $\text{₹} \ 100$, which is $\text{₹} \ 20$, as reserves. It can lend the remaining $\text{₹} \ 80$ (its excess reserves). Suppose the bank lends $\text{₹} \ 80$ to a borrower, Jaspal. The bank opens a new deposit account in Jaspal's name and credits $\text{₹} \ 80$ to it.
2. Impact on Money Supply: The total deposits in the bank are now Leela's $\text{₹} \ 100$ + Jaspal's new loan deposit of $\text{₹} \ 80$ = $\text{₹} \ 180$. The money supply has already increased.
3. Round 2: Jaspal uses the $\text{₹} \ 80$ to pay someone, say Junaid, who then deposits this amount back into the banking system. Now the bank has a new deposit of $\text{₹} \ 80$. It keeps $20\%$ of this, i.e., $\text{₹} \ 16$, as reserves and lends out the remaining $\text{₹} \ 64$.
4. Continuation: This process continues. The $\text{₹} \ 64$ loan is spent and re-deposited, leading to a new loan of $\text{₹} \ 51.20$ ($80\%$ of $\text{₹} \ 64$), and so on. Each round adds a smaller amount to the total deposits. The process stops only when the initial excess reserves ($\text{₹} \ 80$) are fully converted into required reserves across the system.

Limits to Credit Creation: The Money Multiplier

The banking system cannot create an infinite amount of money. The total amount of money created is limited by the initial amount of reserves and the CRR. The Money Multiplier (or deposit multiplier) quantifies this limit.

Derivation of the Money Multiplier

The total increase in deposits is the sum of an infinite geometric series:

Total Deposits = Initial Deposit + Loan in Round 1 + Loan in Round 2 + ...

Let the initial deposit be $\Delta D$ and the CRR be $r$. The amount lent in each round is $(1-r)$ times the deposit of the previous round.

Total Deposits = $\Delta D + (1-r)\Delta D + (1-r)^2\Delta D + (1-r)^3\Delta D + \dots$

The sum of an infinite geometric series is $S = \frac{a}{1-R}$, where $a$ is the first term and $R$ is the common ratio.

Here, $a = \Delta D$ and $R = (1-r)$.

Total Deposits = $\frac{\Delta D}{1 - (1-r)} = \frac{\Delta D}{r}$

So, Total Deposits = Initial Deposit $\times \frac{1}{r}$.

The term $\frac{1}{r}$ is the money multiplier.

Money Multiplier = $\frac{1}{\text{CRR}}$

The multiplier shows the maximum amount of deposits that can be created by the banking system for every one rupee of initial deposits.

Example of the Money Multiplier Process

Using our earlier example:

• Initial Deposit = $\text{₹} \ 100$
• CRR = 20% or 0.2
• Money Multiplier = $\frac{1}{0.2} = 5$
• Total Deposits Created = Initial Deposit $\times$ Multiplier = $\text{₹} \ 100 \times 5 = \text{₹} \ 500$.
• Total Reserves = $20\%$ of Total Deposits = $0.2 \times \text{₹} \ 500 = \text{₹} \ 100$ (which equals the initial deposit).
• Total Loans Created = Total Deposits - Total Reserves = $\text{₹} \ 500 - \text{₹} \ 100 = \text{₹} \ 400$.

The final balance sheet of the banking system, after the multiplier process is complete, will be:

This shows how an initial cash deposit of $\text{₹} \ 100$ has led to a total money supply (deposits) of $\text{₹} \ 500$.

Policy Tools to Control Money Supply

The central bank of a country, the Reserve Bank of India (RBI) in India, is entrusted with the responsibility of managing and controlling the money supply. This is a core function of its monetary policy. The primary objectives of monetary policy are to maintain price stability (control inflation), ensure adequate credit flow to productive sectors, and promote economic growth. To achieve these goals, the RBI employs a range of policy tools, which can be broadly categorized as quantitative and qualitative.

Quantitative Tools (General or Indirect Tools)

These tools are designed to regulate the total volume of money and credit in the economy. They affect the entire banking system indirectly and without discrimination.

1. Reserve Ratios

Reserve ratios directly affect the ability of commercial banks to create credit by altering the size of the money multiplier.

• Cash Reserve Ratio (CRR): As legally mandated, this is the minimum percentage of a bank's Net Demand and Time Liabilities (NDTL) that it must maintain as cash reserves with the RBI. Banks do not earn any interest on these deposits.

  Mechanism: By increasing the CRR, the RBI forces banks to hold more cash with it, thereby reducing their excess reserves available for lending. This directly shrinks the value of the money multiplier ($1/CRR$), thus contracting the money supply. Conversely, a reduction in the CRR releases more funds into the banking system, increases the money multiplier, and expands the money supply.

  Example 1. If the CRR is 4%, the money multiplier is $1/0.04 = 25$. If the RBI increases the CRR to 5%, the multiplier falls to $1/0.05 = 20$. This significantly reduces the banking system's capacity to create credit.

• Statutory Liquidity Ratio (SLR): This is the minimum percentage of NDTL that a commercial bank must maintain with itself in the form of liquid assets. These assets include cash, gold, and unencumbered government-approved securities (like government bonds and treasury bills).

  Mechanism: An increase in the SLR restricts a bank's ability to grant loans by locking up a larger portion of its funds in specified liquid assets. This reduces the overall credit available in the economy. A decrease in the SLR frees up funds for banks to lend, thus increasing the potential money supply.

2. Open Market Operations (OMO)

OMO is the most flexible and frequently used tool of monetary policy. It involves the outright purchase and sale of government securities (G-Secs) by the RBI in the open market.

• To increase money supply (Expansionary Policy): The RBI purchases G-Secs from commercial banks or the public. It pays for these securities by issuing a cheque, which, when credited to the seller's account, increases the reserves of the commercial banking system. This injection of liquidity increases banks' lending capacity, leading to an expansion of the money supply.
• To decrease money supply (Contractionary Policy): The RBI sells G-Secs in the market. Commercial banks and the public purchase these securities, paying the RBI. This withdraws money from the banking system, reduces their reserves, and contracts their ability to create credit, thereby reducing the money supply.

3. Policy Rates (under the Liquidity Adjustment Facility - LAF)

The RBI provides funds to commercial banks to meet their short-term liquidity mismatches. The rates at which these transactions occur are powerful signaling tools for the economy. This mechanism is crucial to the RBI's role as the lender of last resort.

• Repo Rate (Repurchase Rate): This is the key policy rate. It is the fixed interest rate at which the RBI lends money to commercial banks for their short-term needs, against the collateral of government securities.

  Mechanism: When the RBI raises the repo rate, the cost of borrowing for commercial banks increases. This higher cost is passed on to consumers and businesses in the form of higher interest rates on loans (like home loans, car loans, and business loans). Higher loan rates discourage borrowing, reduce aggregate demand, and help control inflation. A cut in the repo rate has the opposite effect, making loans cheaper and stimulating economic activity.

• Reverse Repo Rate: This is the fixed interest rate at which the RBI absorbs liquidity from commercial banks by borrowing from them on an overnight basis against government securities.

  Mechanism: When commercial banks have surplus funds, they can park them with the RBI and earn interest at the reverse repo rate. An increase in the reverse repo rate makes it more attractive for banks to park their funds with the RBI (a risk-free option) rather than lending them out. This absorbs excess liquidity from the system.

• Bank Rate: This is a longer-term rate at which the RBI lends to commercial banks, typically without any collateral. It is often considered a penal rate, charged when banks fail to meet their reserve requirements. While it is not the primary policy tool today, it acts as a benchmark for various other interest rates.

Qualitative Tools (Selective or Direct Tools)

These tools are used to regulate the flow of credit into specific sectors or for particular purposes, rather than affecting the total volume of credit.

• Margin Requirements: This refers to the proportion of a loan's value that a borrower is required to finance from their own funds. It is the difference between the market value of the security offered as collateral and the amount of the loan granted.

  Mechanism: To discourage speculative activities or lending to a particular sector, the RBI can increase the margin requirement. For example, if the margin for loans against shares is raised from 30% to 50%, a borrower with shares worth $\text{₹} \ 1,00,000$ can now only get a loan of $\text{₹} \ 50,000$ instead of $\text{₹} \ 70,000$. This selectively curbs credit flow to that specific activity.

• Moral Suasion: This is a non-binding but often effective tool where the RBI uses persuasion, advice, and informal suggestions to convince commercial banks to follow its policy directives. The RBI Governor may hold meetings with the heads of banks to advise them on their lending policies, for instance, to encourage lending to priority sectors like agriculture or to be more cautious about lending for speculative purposes.

Measures of Money Supply and Related Concepts

Understanding the demand for and supply of money is fundamental to macroeconomics. The demand for money explains why individuals and firms choose to hold liquid assets, while the supply of money refers to the total stock of money available in an economy at a specific point in time. The central bank, RBI, not only manages this supply but also measures it using various aggregates.

Detailed Discussion on Demand for Money

The demand for money is often referred to as liquidity preference. It involves a trade-off: holding money provides the advantage of liquidity (it can be used for transactions immediately), but it comes with an opportunity cost—the interest or returns that could have been earned by holding wealth in other assets like bonds or fixed deposits.

1. The Transaction Motive

The principal reason for holding money is to facilitate transactions. There is typically a mismatch between the timing of income receipt and expenditure. For example, an individual may receive a salary once a month but needs to make purchases continuously throughout the month.

The total transaction demand for money in an economy, $M_T^d$, is therefore positively related to the total value of nominal transactions ($T$).

$M_T^d = k \cdot T$

Where $k$ is a positive fraction. Since the total value of transactions is closely related to nominal GDP ($PY$), the equation is often written as:

$M_T^d = kPY$

The term $1/k$ is called the velocity of circulation of money ($v$), which is the number of times a unit of money changes hands during a period. So, $v \cdot M_T^d = PY$.

2. The Speculative Motive

This motive arises because money can also be held as an asset. Individuals may speculate on the future movements of interest rates and bond prices. A bond is a financial instrument that promises a future stream of monetary returns. The key principle here is the inverse relationship between bond prices and the market rate of interest.

Present Value and Bond Price: The price of a bond is the present value (PV) of its future income stream, discounted at the current market rate of interest.

Answer:

Based on this, speculative behavior is as follows:

• When the interest rate is very high, people expect it to fall. A fall in interest rates will increase bond prices, leading to a capital gain. Thus, people will buy bonds and hold less money. Speculative demand for money is low.
• When the interest rate is very low, people expect it to rise. A rise in interest rates will decrease bond prices, causing a capital loss. To avoid this, people will sell bonds and hold more money. Speculative demand for money is high.

Liquidity Trap: This is an extreme situation where the interest rate is so low ($r_{min}$) that everyone expects it to rise. The speculative demand for money becomes infinitely elastic (a horizontal line). In this scenario, any extra money injected into the economy is simply held by people as cash, and monetary policy becomes ineffective at lowering the interest rate further.

The Supply of Money: Definitions and Measures

Fiat Money and Legal Tender

The money in a modern economy, consisting of currency notes and coins, has very little intrinsic value. A $\text{₹} \ 500$ note is just a piece of paper. It is accepted as money because its value is derived from the guarantee or order ("fiat") of the issuing authority (the RBI). This type of money is called fiat money.

Currency notes and coins are also designated as legal tender. This means that by law, they cannot be refused by any citizen of the country for the settlement of any transaction or debt. However, cheques, which are drawn on demand deposits, are not legal tender and can be refused as a mode of payment.

Legal Definitions: Narrow and Broad Money

The RBI publishes four alternative measures of money supply, categorized based on their degree of liquidity. Liquidity refers to how quickly and easily an asset can be converted into cash to be used for transactions.

The core components are:

• CU: Currency (notes and coins) held by the public (i.e., outside the banking system).
• DD: Net Demand Deposits held by the public in commercial banks. These are chequable deposits, like those in current accounts and savings accounts, which can be withdrawn on demand. The word ‘net’ implies that inter-bank deposits (deposits held by one commercial bank in another) are excluded from the money supply.

The four measures are:

Narrow Money (High Liquidity)

These are the most liquid forms of money, readily available for spending.

• M1 = CU + DD

  M1 represents the most liquid portion of the money supply, as its components are used directly as a medium of exchange.

• M2 = M1 + Savings deposits with Post Office savings banks

  This adds another highly liquid component to M1, although Post Office savings are slightly less accessible than commercial bank deposits.

Broad Money (Lower Liquidity)

These measures include less liquid assets, primarily time deposits.

• M3 = M1 + Net time deposits of commercial banks

  Time deposits (like Fixed Deposits or FDs) have a fixed maturity period and cannot be withdrawn on demand without a penalty. Including them makes M3 a "broader" and less liquid measure than M1. M3 is the most widely used measure of money supply in India and is also known as Aggregate Monetary Resources.

• M4 = M3 + Total deposits with Post Office savings organisations (excluding National Savings Certificates)

  This is the broadest measure, including all Post Office deposits, making it the least liquid of the four.

The aggregates are arranged in decreasing order of liquidity: M1 is most liquid > M2 > M3 > M4 is least liquid.

Demonetisation

Demonetisation is the act of stripping a currency unit of its status as legal tender. The Government of India undertook a major demonetisation exercise in November 2016. The existing currency notes in the denomination of $\text{₹} \ 500$ and $\text{₹} \ 1000$ were withdrawn from circulation and ceased to be legal tender.

Stated Objectives:

The primary aims of this move were to tackle several critical economic issues:

• To curb black money (undisclosed and untaxed income).
• To fight against corruption.
• To eliminate the circulation of high-quality fake currency in the economy.
• To disrupt the financing of terrorism and other illicit activities.

Implementation and Impacts:

The public was given a window to deposit the old currency notes into their bank accounts. New currency notes in the denomination of $\text{₹} \ 500$ and $\text{₹} \ 2000$ were launched. The move received both appreciation and criticism and had several significant impacts:

• Negative Impacts: In the short run, the move caused a severe cash crunch and widespread disruption. There were long queues outside banks and ATM booths. The shortage of currency in circulation had an adverse impact on economic activity, particularly in the cash-intensive informal sector, agriculture, and small businesses.
• Positive Impacts: Over time, several positive outcomes were observed.
  • It improved tax compliance as a large amount of cash was brought into the formal banking system, bringing many people into the tax ambit.
  • Savings were channelized into the formal financial system. As a result, banks had more resources (deposits) at their disposal, which could be used to provide more loans at potentially lower interest rates.
  • It acted as a strong deterrent against tax evasion and corruption.
  • Perhaps one of the most significant long-term impacts was the massive push it gave to the digital economy. Households and firms began to shift rapidly from cash to electronic payment technologies like e-Wallets, UPI, and card payments.

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