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On Nov. 8, 2016, Narendra Modi, the prime minister of India, stepped in front of TV cameras and announced that the nation would almost immediately begin getting rid of most of its cash. Indians would have to exchange or deposit their large rupee bills in a matter of weeks — or else the bills would become worthless. Poof. Gone. The policy was supposed to end corruption, counterfeiting and a large shadow economy; it was also a push to turn India's backward, cash-dependent economy into a modern, electronic one.
But what followed proved to be chaos.
The surprise announcement sent millions and millions of Indians scrambling to exchange their cash. They left their jobs and waited in long lines at the bank. They upended their lives trying to preserve their savings. Businesses, starved of payments, crumbled. The whole story is nuts, and Planet Money has two great episodes that tell it. You can listen to them here and here.
It has now been a few years since India's "demonetization," as Modi called it. And the data are coming in. A new study, forthcoming in the prestigious Quarterly Journal of Economics, gives us a one-of-a-kind look at what this radical policy meant for the economy.
Gabriel Chodorow-Reich is an economist at Harvard University, and he and his colleagues quickly saw demonetization as a perfect "natural experiment," a rare opportunity to look at how economic theory plays out in the real world.
You might think that Chodorow-Reich and his team could have just looked at official statistics, like gross domestic product, to get the story. But GDP misses a lot, especially in a country like India, where there is a massive underground economy. To get around this problem, Chodorow-Reich and his colleagues used other measures, like satellite imagery of lights at night. When people spend money, restaurants, factories, bars and cars light up the night sky. The idea is more light, more economic activity. Economists have increasingly been using changes in night luminosity, as seen from space, as a way to measure economic growth in places where official statistics are spotty.
The Indian government wiped out 500- and 1,000-rupee notes, representing 87% of the total cash in circulation. It then shipped in new types of bills, which are harder to counterfeit, to the roughly 600 districts in the country. The new bills were sent to districts at different speeds and in different batches, and Chodorow-Reich says that this wasn't done with much recognition of where the old notes came from. As a result, some districts became much more starved for cash than others, and the economists used data on these cash shortfalls to measure the effect of cash on economic growth.
Chodorow-Reich and his team found that the policy of rapid demonetization caused a 2 percentage point crash in economic growth during the first few months after the policy was announced. To put that in perspective, the Indian economy was growing at just over 2% per quarter during this period. So essentially, the policy halted economic growth. The decline could be seen by satellites at night; the country looked dimmer.
There's currently a movement to get rid of cash. One of its leaders is Chodorow-Reich's colleague at Harvard, Kenneth Rogoff. Rogoff wrote a book called The Curse of Cash, and he makes the case that eliminating large bills will have all sorts of societal benefits, starting with a reduction in crime and corruption.
Chodorow-Reich's study raises the prospect that the movement to get rid of cash has a real cost. But he cautions that such a policy might work out differently in a country like the United States. India has a massive population of people without bank accounts, credit cards or payment apps — and the United States is much more advanced in this regard. It's not as dependent on cash.
India surely suffered under this policy, but Chodorow-Reich and his team do find that it helped promote the adoption of electronic forms of payment. Moreover, once new cash replaced the old notes and people adjusted to the new payment systems, things returned to normal. "If India had been able to print those notes and distribute them instantaneously, there wouldn't have been any problem," Chodorow-Reich says.
Which is why Chodorow-Reich advises that if a country wants to get rid of cash, it should heed this key lesson from India: "You don't want to do it suddenly," he says. "There are adjustment costs."
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