Sagar Wadhwa
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Working Paper
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In November 2016, the Government of India made the two highest denomination currency notes invalid overnight. While this move was proposed for potential future benefits, it resulted in severe liquidity con- straints for many households as these two notes constituted 86% of the total currency in circulation. In this paper, I study the impact of resulting liquidity constraints on household consumption using Consumer Pyramids panel data. I find that demonetization led to a decline in household durable and non-durable con- sumption in the initial months after demonetization. The decline was relatively higher for richer households. I also find that households increased borrowing after demonetization, particularly from money lenders. The increase in borrowing was relatively higher for poorer households. Focusing on heterogeneity among farmers, I show that the use of credit was higher for those households who rely more on cash. The results suggest that while richer households reduced their consumption because it came at a lower utility cost to them, poorer households had to rely on informal credit to maintain their consumption.

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