Parag Waknis, Ambedkar University

A surprise demonetization, where certain or all denominations of currency notes cease to be legal tender within 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 featuring goods and financial market segmentation to analyze the effects of such a shock in an economy with substantial informality and cash dependence. I provide a quantitative characterization of the equilibrium dynamics using a deterministic and a stochastic process that mimics the recent demonetization and remonetization exercise in India.

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