Cash and the Economy: Evidence from India's Demonetization

61 Pages Posted: 17 Dec 2018

See all articles by Gabriel Chodorow-Reich

Gabriel Chodorow-Reich

Harvard University Department of Economics

Gita Gopinath

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Prachi Mishra

Goldman Sachs Group, Inc.

Abhinav Narayanan

Government of India - Reserve Bank of India

Date Written: December 2018

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.

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Suggested Citation

Chodorow-Reich, Gabriel and Gopinath, Gita and Mishra, Prachi and Narayanan, Abhinav, Cash and the Economy: Evidence from India's Demonetization (December 2018). NBER Working Paper No. w25370. Available at SSRN: https://ssrn.com/abstract=3302554

Gabriel Chodorow-Reich (Contact Author)

Harvard University Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
6174963226 (Phone)
6174963226 (Fax)

HOME PAGE: http://scholar.harvard.edu/chodorow-reich

Gita Gopinath

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Prachi Mishra

Goldman Sachs Group, Inc. ( email )

85 Broad Street
New York, NY 10004
United States

Abhinav Narayanan

Government of India - Reserve Bank of India ( email )

Bakery Junction Service Road
Vazhuthacaud
Thiruvananthapuram, Kerala 695033
India

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