Cash and the Economy: Evidence from India's Demonetization

Abstract

We analyze a unique episode in the history of monetary economics, the 2016 Indian "demonetization." This policy made 86% of cash in circulation illegal tender overnight, with new notes gradually introduced over the next several months. We present a model of demonetization where agents hold cash both to satisfy a cash-in-advance constraint and for tax evasion purposes. We test the predictions of the model in the cross-section of Indian districts using several novel data sets including: the geographic distribution of demonetized and new notes for causal inference; nightlight activity and employment surveys to measure economic activity including in the informal sector; debit/credit cards and e-wallet transactions data; and banking data on deposit and credit growth. Districts experiencing more severe demonetization had relative reductions in economic activity, faster adoption of alternative payment technologies, and lower bank credit growth. The cross-sectional responses cumulate to a contraction in employment and nightlights-based output due to demonetization of 2 p.p. and of bank credit of 2 p.p. in 2016Q4 relative to their counterfactual paths, effects which dissipate over the next few months. These cumulated effects provide a lower bound for the aggregate effects of demonetization. Our analysis rejects money non-neutrality using a large scale natural experiment, something that is yet rare in the vast literature on the effects of monetary policy.

Examining the economic impact of COVID-19 in India through daily electricity consumption and nighttime light intensity

“…The use of satellite-derived data has made substantive inroads in the recent economic literature (Burchfield et al 2006, Donaldson andStoreygard 2016). Nighttime light data has been extensively used in a wide array of economic studies ranging from monitoring economic activity (Henderson et al 2012, Keola et al 2015, Henderson et al 2018 to assessing regional economic convergence (Chanda and Kabiraj 2020) to identifying urban spaces and markets (Gibson et al 2017, Baragwanath et al 2019, Galdo et al 2019, Ch et al 2020 to predicting welfare (Jean et al 2016), and to assessing the quality More recently, nighttime light data has been used to evaluate the economic impact of India's demonetization in November 2016 (Beyer et al 2018, Chodorow-Reich et al 2020.…”

“…Both proxies have also been used to assess the economic impact of major policy measures. Nighttime light intensity, for example, allowed assessing the impact of India's demonetization in November 2016 (Beyer, Chhabra, Galdo, andRama 2018, Chodorow-Reich, Gopinath, Mishra, andNarayanan 2020). It is also invaluable to approximate economic activity at the sub-national level, including in India (Gibson, Datt, Murgai, Ravallion 2017, Prakash, Shukla, Bhowmick, and Beyer 2019, Chanda and Kabiraj 2020.…”

India Development Update, July 2020

“…Night-time light data has proven to be a very helpful source of information in India as well. For example, night-time light data has been used to evaluate the economic impact of India's demonetization in November 2016 (Beyer et al 2018, Chodorow-Reich et al 2020, to approximate state-level economic activity (Prakash, Shukla, Bhowmick, and Beyer 2019), to assess regional convergence in India (Chanda and Kabiraj 2020), and to analyse urban growth (Gibson, Datt, Murgai, Ravallion 2017. Both electricity consumption and night-time light track overall economic activity, including activity in the informal sector.…”

Comparative Analysis of the Changes in Cash Demand in Hungary

“…The temporary cash shortage arising during demonetisation, in contrast to the government's intentions, reinforced the role of the informal economy, and overall had a highly negative impact on poorer classes living in rural areas that had no large amount savings or access to bank accounts (Guérin et al 2017). In addition, Chodorow-Reich et al (2018) used mathematical models to confirm that regions where cash shortage arising as a result of demonetisation was greater saw a more substantial decline in both the performance of the economy and lending.…”