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Business News/ Politics / Policy/  Anatomy of a recession
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Anatomy of a recession

There are several ways in which money supply can be defined. Here we will look at one such definition

Photo: BloombergPremium
Photo: Bloomberg

While it is well known that India suffered from the effects of the global economic downturn in 2008, it is always interesting to see it from different angles, based on different data sources. Economic “events" are like the elephant in John Godfrey Saxe’s poem on the six blind men of “Indostan" (bit.ly/1IsDNiI), and looking at them from different points of view always offers a fresh perspective. We will look at the economic downturn in India from the point of view of money supply.

There are several ways in which money supply can be defined, at different levels of “breadth". Some measures only count money as a medium of exchange, while some others also include money as a store of value (long-term deposits, etc.), while even broader measures also look at close substitutes of money while counting money supply. Central banks normally use broader definitions of money supply while determining monetary policy. Here, we will look at an extremely narrow definition of money supply, counting only the total amount of notes and coins in circulation. And to measure the health of the economy, we will look at how many times the money “turns over" in a given year. A sign of a healthy economy is a high level of economic activity that implies a large number of transactions, which implies that money changes hands multiple times. During an economic downturn, however, as the probability of a rainy day increases, people become more conservative and spend less. As a consequence, money turns over less often.

A version of this graph had appeared in this newspaper on 10 April, where the total supply of currency was plotted as a proportion of the gross domestic product (GDP). Here, we turn it around, looking at GDP as a multiple of the total amount of notes and coins in circulation, the average of the money in circulation at the beginning of the year and money in circulation at the end of the year. This graph shows the nominal GDP (i.e. not adjusted for inflation) as a multiple of the average amount of notes and coins in circulation during the financial year (we get this latter number by averaging the money in circulation at the beginning and end of the year), and tells us the story of the recession.

The number of times money turned over steadily dropped through the mid-2000s, but then saw a sharp fall in 2008-09, when the global recession hit. It fell further in 2009-10, as the economy sank further, but then recovered in 2010-11 as the stimulus came into place and continued to rise.

From the point of view of this graph, it seems like the fiscal and monetary stimulus actually worked, for the money in circulation started being turned around more often after that. However, based on other data sources, we know that the reason the rupee turned over more often in this time period was not due to a growth in the volume of transactions (i.e. growth in economy), but due to a rise in prices (inflation). This graph illustrates the limitations of any such stimulating interventions—all that policymakers can hope for is for getting people to spend more, and to get the money in circulation turn over more rapidly. From this narrow point of view, the stimulus was actually a success. Except that people spent more not because they transacted more, but because prices increased.

It must be mentioned that this is not an entirely correct graph, and it is unlikely to withstand academic scrutiny—the definition of money supply used here is hardly used, and cash accounts for only a small portion of all transactions. Yet, from the perspective of telling us the story of the recession and the subsequent stimulus, it is quite enlightening.

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Published: 20 Apr 2015, 12:28 AM IST
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