City Sunday

Print money to fight slowdown

Though India is slowly opening up its economy after a prolonged lockdown, the correction in the downward slide is unpredictable. Therefore, it is important to be conservatively positive about the economy and analyse the situation at a more granular level for making timely public policy interventions. Economists and financial experts worldwide believe that printing money as part of quantitative easing will generate consumer demand, kickstart new projects, support businesses and the workforce. The US, Europe, Japan, Turkey and Indonesia are printing money and implementing measures, to bring their economies back to normal. The printing of money as a fiscal measure works as per the Keynesian notion, where you enhance spending and consumption, which in turn increase the income equal to multiplier times. Every economy has its own value of the multiplier, which increases the income equal to multiplier times of consumption. It is vital to grasp the functioning of the multiplier to understand and propose the printing of notes.

The concept of the multiplier was first formally introduced into economic theory by RF Kahn in 1931and then was taken up by Keynes (1936). The Keynes-Kahn multiplier says that if the government expenditure (G) goes up by one unit, it translates to more than one unit increase in aggregate demand. The initial round of spending stimulates further rounds of spending such that ultimately the effect on output is multiplier times the original increase in spending. For an initial increase in government expenditure DG and marginal propensity to consume (MPC), change in output DY is K times DG, where K is the fiscal multiplier and equals, K = 1/(1-MPC), under the assumption of a closed economy. The value of the fiscal multiplier is the accumulated effect on output through various rounds of spending. One person’s consumption is the other person’s income.

Suppose the government spends Rs 1 lakh crore through the printing of notes and the MPC of the economy is 0.75, the value of the multiplier will be four. It means for Rs 1 lakh crore of spending, income will increase to Rs 4 lakh crore if other assumptions are fulfilled. Moreover, it doesn’t stop here only and the super multiplier will also work. In a situation where investment is determined by the growth of income itself, we have the operation of what Lange (1943) had called the “compound multiplier” and Hicks (1950) had called the “super multiplier.” Conceptually there is a difference between the multiplier and the super multiplier that subsumes the effect of increased spending on investment via the accelerator (A). However, when we talk about the empirical estimation of the aggregate effect of changes in fiscal variables on the aggregate level of activity, we usually consider the combined concept of super-multiplier as the fiscal multiplier. It can further multiply the income and employment manifold depending upon the capital-output ratio in the Indian economy. Suppose the value of acceleration is again three, this will increase the income many times as the value of A which is A= I/Y, and K=DY/DI and so on. The investors can also be induced with the increase in aggregate demand. The Indian Government’s revenue will also rise with the increase in income and employment.

The fiscal multiplier will work inversely if spending is reduced, which is happening right now in the Indian economy due to the huge job losses and even salary reductions. It will negatively affect the economy, which is already in turmoil. So, the Government should not use the measures which can reduce consumer spending.

Critics will say that prices will rise with the printing of notes. Well, the economy is in huge deflation and there is a scope of the economy hotting up to some extent. Moreover, interest rates are going down to reduce the cost of production. In short, the multiplier effect will be larger when some conditions are fulfilled: The propensity to spend extra income on domestic goods and services is high, the marginal rate of tax on extra income is low, consumer confidence is high and businesses have the capacity to expand production to meet demand. The leakages in the form of imports are already low, which makes multiplier more effective.

Quantitative easing will help generate “helicopter money” to empower the public with money to buy things and boost the economy. Obama did it for the US economy during the 2008 crisis. This concept can be re-invented into a “Drone Drop Money” (DDM) for us. This money should directly go to the individual. The difference between DDM and “helicopter money” is that due to COVID-19, you cannot opt for spending in public works to a major extent. It is the best time to go for printing of money and much-needed, too. There should be a reduction in direct and indirect taxes to boost consumption further, which will increase the tax revenue as per the Laffer Curve. In the current crisis, everyone needs support. Vulnerable people need cash transfers. Large companies need support for liquidity. Small companies may require protection from bankruptcy. Those nations which take timely measures will fare better in reviving the economy. The Centre should come out with a huge package of about ten per cent of the GDP immediately, which might help revive the economy. It could be a V-shaped revival as soon as the lockdown ends. (MR, Inputs: Agencies).

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