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; night light 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 aggregate employment and night lights–based output due to the the cash shortage of at least 2 percentage points and of bank credit of 2 percentage points in 2016Q4 relative to their counterfactual paths, effects that dissipate over the next few months. Our analysis rejects monetary neutrality using a large-scale natural experiment, something that is still rare in the vast literature on the effects of monetary policy.

Identification in Macroeconomics

“…Many economists find the narrative account above and the accompanying evidence about output to be compelling evidence of large monetary nonneutrality. 11 However, there are other possible explanations for these movements in output. There were oil shocks both in September 1979 and in February 1981 (described in Table D.1 in the online Appendix).…”

“…If not for this, it would have been much harder to attribute the movements in output to changes in policy. 11 The Volcker disinflation has also had a profound effect on beliefs within academia and in policy circles about the ability of central banks to control inflation. Today the proposition that inflation is "always and everywhere a monetary phenomenon" is firmly established; so firmly established that it is surprising to modern ears that this proposition was doubted by many in the 1970s (Romer and Romer 2002;Nelson 2005).…”

Demonetization and Improvisation of Value Chain Dynamic in Afghanistan: An Exploratory Study

“…All the small and medium-size businesses affected, and the common man and poor people suffered immense complicity in adjusting to using digital technology. As the primary purpose of demonetization was to eradicate black money, counterfeit currency, and terrorist funding (Chandrasekhar & Ghosh, 2018;Chodorow-Reich, Gopinath, Mishra, & Narayanan, 2020;Kumar, 2017;Mahajan & Singla, 2017;Mukherjee, 2019;Sivathanu, 2019;Thakur & Srivastava, 2013), studied the impact of demonetization in the Indian economy. (Ghosh, 2016;Kumar, 2017;Mahajan & Singla, 2017;Thakur & Srivastava, 2013), found that the purpose of demonetization is not served as the cashless society was a bit troublesome to the general public.…”

“…(Ghosh, 2016;Kumar, 2017;Mahajan & Singla, 2017;Thakur & Srivastava, 2013), found that the purpose of demonetization is not served as the cashless society was a bit troublesome to the general public. However, (Chodorow-Reich et al, 2020;Mukherjee, 2019) found that demonetization increased India's digital transactions. (Sivathanu, 2019), found that the target of demonetization partially served.…”

Demonetisation, Banking and Trust in ‘Bricks’ Or ‘Clicks’

“…Public reactions soon reflected people’s shock and loss of trust in a government that overnight devalued their hard-earned cash. Given that the devalued currency notes constituted 86 per cent of currency in circulation at the time in terms of value (Agarwal et al, 2019: 8; Chodorow-Reich et al, 2020: 57), this had major impacts on trust, affecting everybody’s lives. Indeed, criticism of this ‘impetuous action’ (Singh, 2016) was instant and fierce.…”