Demonetization: When 86% of India’s Currency Disappeared

In November 2016, India’s prime minister announced that all bills over 500 rupees were demonetized in an attempt to fight corruption. As a result, 86% of India’s currency disappeared overnight! Harvard’s Gabriel Chodorow-Reich and his coauthors took advantage of this sudden natural experiment to examine the role of money in modern economies.

Different districts of India took different approaches to demonetization—some replaced the currency quickly while others took longer. But studying the various effects was difficult because of a lack of reliable data.

By using employment surveys—simply measuring whether people are working—and satellite-based night light activity—measuring how much light is being generated in a particular location—Chodorow-Reich and his team were able to compare economic outcomes across regions with a high degree of accuracy.

This video is based on the following paper: Cash and the Economy: Evidence from India's Demonetization by Gabriel Chodorow-Reich, Gita Gopinath, Prachi Mishra, and Abhinav Naraynan.

Teacher Resources


In November of 2016, the Prime Minister announced a policy to root out the black money. So overnight, 86% of the currency disappeared, and it took about eight months for them to print enough new notes to replace that currency. 

The government of India was worried about a problem they called black money. And black money was currency that people held that was ill-gotten. So it could be a corrupt government official who had been taking bribes for many years in cash and then was sitting on all these notes in their house. It could be terrorists who were printing counterfeit notes, rupee notes, and using those to finance their terrorism activities. 

And what the policy did was it said all of the large bills you have, overnight, were no longer usable to buy goods at stores. So if you held them, you could bring them to your bank, and you could turn them in for deposits, as long as you could show that you hadn't gotten these notes corruptly. This policy was called "demonetization.”

The intention was then to reintroduce new notes, and this would root out corruptly accumulated hoards of cash. The problem is, in modern economies, it takes a long time to print notes. So overnight, 86% of the currency disappeared, and it took about eight months for them to print enough new notes to replace that currency. 

So this is a sudden large drop in money, and it's sort of a classic natural experiment to try and understand what's the role of money in society. What does it matter? Does it actually improve welfare? So what we tried to do was use variation across districts in India. 

And so you had some districts who relatively quickly had had the currency replaced and, therefore, had a fairly transient, short-lived shock. You had other districts that waited much longer to get new notes. Since then, we compared economic outcomes across those districts, and that was a way of trying to disentangle the causality of this particular policy on the economy. 

At the time of demonetization, there were widely varying predictions, so the government didn't think this was going to be a big deal. There were private economists who thought this could cause a recession in the order of 7% or 8% of the economy. So just figuring out which of those two was correct would tell us a lot about how the economy works and the role of money. 

So a challenge in doing research in India is a lack of high-quality data, especially at the regional level. So to measure regional outcomes, we use two main things. One was an employment survey, so this measured whether people were working, and we were able to track in those districts that had larger currency contractions where people worked less. 

The other one is what's called satellite-based night light activity. This is a very high resolution, so up to a square kilometer, and they measure how much light is being generated from that particular location. And it turns out that human-generated light is correlated with economic activity and economic development. 

Demonetization is a particularly unique event. It could be that another country would think about doing a demonetization sort of activity. A particularly concrete example of what policy countries have considered is leaving the euro. Greece, in particular, faced the prospect where they thought about leaving the euro and going back to the pre-euro currency in Greece, which was the drachma. And so what happens if, overnight in Greece, people don't have paper currency anymore? -- and it takes a while to print the new drachmas.

Understanding how much demonetization affected the Indian economy tells us something about whether that would have a consequence on the Greek economy. Demonetization is a great example of a large scale macroeconomic policy, and these policies can affect a lot of people -- they affect employment rates, they affect unemployment rates. And it's an important question for economists to understand, what are the effects of these policies


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