Abstract
In a previous paper, we analyzed an economic event in 2016-17 of a sudden demonetarization of India, to test the empirical validity of the Chartalist school of monetary theory. The Chartalist school had distinguished three kinds of money: Fiat, Commodity, and Managed Money. The demonetarization event provided empirical evidence for this currency distinction being significant and empirically valid, in the context of the nation of India. That sudden withdrawal of Fiat money immediately decreased the amount of Commodity money, creating an economic crisis in local Indian commerce. Managed Money (as bank accounts) was unable to fill the temporary gap in the supply of money, because a large portion of the Indian population did not have bank accounts. Also the government had not supplied a sufficient number of new Fiat money (new 500 and 2000 rupee notes) to quickly replace the withdrawn 500 and 1000 rupee notes. Our analysis showed that the policy thinking behind the demonetarization event lacked a proper understanding of valid monetary theory. In this paper, we continue the analysis of the demonetarization event by constructing a model of monetary flow in India. This model builds upon the Chartalist theory of money and may help fiscal policy makers to make sound decisions about currency and credit in a nation.
Highlights
Our analysis showed that the policy thinking behind the demonetarization event lacked a proper understanding of valid monetary theory
The model of the flow of currency within an economy should trace the flow between the public and private sectors, because fiat money is created in the public sector
In the public sector of a modern economy, we indicate three functional components: a government treasury, a national central bank, and a foreign exchange for the national fiat currency
Summary
The model of the flow of currency within an economy should trace the flow between the public and private sectors, because fiat money is created in the public sector. Wray’s accounting model for a two-sector economy (private and public) is that fiat money is issued by the government for the function of collecting taxes.
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