Munich Personal RePEc Archive

Demonetization as a Payments System Shock under Goods and Financial Market Segmentation: A Short Run Analysis

Waknis, Parag (2019): Demonetization as a Payments System Shock under Goods and Financial Market Segmentation: A Short Run Analysis.

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Abstract

A surprise demonetization, where certain or all denominations of currency notes cease to be legal tender on a short notice, can be understood as a severe payment system shock requiring agents to immediately shift to alternative payment mechanisms. I use a short-term macroeconomic model based on Willamson (2009) featuring goods and financial market segmentation to analyze the effect of such a shock in an economy with substantial informality and cash dependence. The quantitative characterization of the equilibrium dynamics using a deterministic example shows significant level as well as redistributive effects in the very short run. The households with access to formal financial markets experience an increase in consumption and those without such access experience a decline. Most of these effects come from differential access to formal financial markets as a consumption smoothing mechanism.

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