How to reduce the risk of recession and help the poor after demonetization

In a recent article, I had warned that there is a serious risk that demonetization will lead to a decline in the GDP. In the same vein, the Economist magazine concluded

Economists reckon that the currency squeeze will knock 0.5–1 percentage points off India’s growth rate in each of the next two quarters.

In this article, I suggest a way to reduce the risks of a recession and also help poorer people.

It is standard economic theory that Governments should increase expenditures or reduce taxes when there is fear of a recession. Most recently, this type of expenditure came to be called as the stimulus in the US. The US stimulus package included tax rebates or tax rebates of $ 300 per person, with wealthier people getting progressively lower amounts.

The reason to give tax rebates is to stimulate consumption expenditures. An alternative to such rebates is for the Government to spend the money. And, the US government did do this. But, it is well-known that it takes a long time for any government to spend money on new projects. The US government looked for “shovel-ready” projects to spend money on, but it was difficult to find them quickly.

It is likely that the Indian government’s revenues will increase as a result of the crackdown. For example, the amnesty drive that ended in October 2016 gave the government an additional Rs 29,400 crores. This is about 8% of total Indian government income tax revenues (which are around Rs 328,463 crores.)

My proposal is that the Indian government should rebate all the additional revenues (taxes, fines) arising demonetization into Jan Dhan accounts. At present, there are around 21–22 crore such accounts. Thus, if the Indian government collects an amount similar to what it collected from the amnesty scheme, then this would mean about Rs 1,400 (Rs 29,400 crores/21.5 crore accounts) in each Jan Dhan account.

This would be a significant boost in Jan Dhan accounts. In February 2016, the average balance in each non-zero Jan Dhan account was only about Rs. 2,200. And, there was many zero-balance Jan Dhan accounts.

Not all of this windfall into the Jan Dhan accounts would be spent. Perhaps only half of the windfall would be spent. (Technical note: people’s consumption is guided by their ‘permanent’ income, not by windfalls or shortages.) Almost of this would be spent on Indian goods and services — poor people buy few imported goods. In turn, this would set off a Keynesian stimulus in the Indian economy.

Thus, the poor would be the beneficiaries of the additional taxes and fines paid by people with black money. These were the people who suffered the most from the long lines and delays in getting new currency notes. And, the expenditures of the poor would help reduce the risk of recession.

In short, economic justice and economic growth.

Read my complete series on demonetization of currency in India:

India’s demonetization may lead to a recession

India’s demonetization will hurt poor borrowers and micro/small enterprises

How to reduce the risk of recession and help the poor after demonetization

India’s Demonetization: What will happen when the lines end at banks and ATMs?

Ongoing IIT placements portend an economic slowdown in India in 2017

Don’t blame civil servants for India’s demonetization problems

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