Impact of GST and Demonetization on GDP Growth

Understanding the relationship between Gross Domestic Product (GDP) growth and monetary policies is crucial for macroeconomic success. Two significant policies that have recently impacted the economy are GST (Goods and Services Tax) and demonetization. This article explores the potential impacts of these policies on GDP growth, focusing on the role of money supply and velocity of money.

Introduction to GDP Growth

GDP growth can be understood as a function of various economic factors, two of the most important being the money supply and the velocity of money. The money supply refers to the total amount of money in an economy, while the velocity of money is the frequency with which money changes hands within the economy.

Demonetization and Its Impact on Money Supply

One of the key factors affecting GDP growth is the money supply. Demonetization, the withdrawal and invalidation of old currency notes, is a policy often implemented to curb black money and tax evasion. While demonetization itself does not immediately reduce the money supply, it can lead to a contraction of money supply if citizens do not have immediate access to new alternative currency.

During the period of transition, if citizens are unable to exchange demonetized currency for new currency, cash transactions will cease, leading to a temporary contraction in the money supply. This reduction in liquidity can have a negative impact on economic activities, as businesses and consumers experience difficulty in making transactions. However, such a contraction is usually temporary and is corrected when citizens have access to new currency.

Does GST Reduce GDP Growth?

Another significant economic reform introduced is the Goods and Services Tax (GST). GST is a comprehensive indirect tax that subsumes a number of existing taxes such as sales tax, service tax, and value-added tax. Unlike demonetization, which is a measure to control cash circulation, GST primarily impacts the system of taxation.

While GST is likely to cause cost-push inflation due to increased tax burden, it does not directly impact the money supply or the velocity of money. The primary effect of GST is to streamline tax collection processes and reduce the cascading nature of taxes, but it does not alter the total amount of money or how frequently it is used in transactions.

Implications for GDP Growth

The impact of both demonetization and GST on GDP growth can be analyzed through the lens of their effects on money supply and velocity of money:

Demonetization: Direct impact on money supply during the transition phase, but generally short-lived. Cost-Push Inflation due to GST: Potential for higher prices in the short term, but not a direct reduction in money supply or velocity of money.

Both policies affect the economy differently. Demonetization affects immediate liquidity and can cause temporary economic disruption, while GST influences tax transparency and efficiency but not the overall money supply. The impact on GDP growth, therefore, is more of a transitional phase rather than a sustained reduction in growth.

Conclusion

In conclusion, the impact of demonetization and GST on GDP growth is multifaceted. While demonetization can cause a temporary contraction in the money supply, GST primarily affects inflation through cost-push mechanisms. Both policies have short-term effects but are less likely to cause sustained reduction in GDP growth when viewed in terms of their impact on key economic factors such as money supply and velocity of money.