The Political Impact of Monetary Shocks: Evidence from India's 2016 Demonetization

Abstract

What are the political consequences of monetary shocks? While theories of retrospective voting suggest that voters should punish incumbents for negative economic shocks within incumbents' control, other works suggest voters' ability and willingness to do so are limited. We examine this issue by tracing the impact of the sudden demonetization of 86% of India's currency in 2016. We argue and show, using difference-in-difference and instrumental variables analyses, that the economic impact of demonetization was felt most acutely in relatively areas, where households and businesses lack access to the formal financial system and are most cash-dependent. Further, the BJP, the incumbent party that implemented demonetization, was penalized the least in relatively unbanked districts where people were economically hurt the most. We speculate why this might be the case. Our findings illustrate that monetary policy has important distributional consequences that shape voting.