Working Paper: NBER ID: w25370
Authors: Gabriel Chodorow-Reich; Gita Gopinath; Prachi Mishra; Abhinav Narayanan
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.
Keywords: Demonetization; India; Cash; Economic Activity; Monetary Policy
JEL Codes: E50; E23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| severe demonetization shock (E49) | reduction in economic activity (F69) |
| reduction in cash availability (E41) | slowdown in bank credit growth (E51) |
| reduction in cash availability (E41) | lower growth rate of economic activity (O49) |
| severe demonetization shock (E49) | decline in cash availability (E41) |
| decline in cash availability (E41) | faster adoption of alternative payment technologies (E42) |
| severe demonetization shock (E49) | contraction in employment (J63) |
| demonetization shock (E39) | decline in ATM activity (G21) |