Payment-System Development and the Real Economy : Implications from India’s Demonetization

With cashless transactions gaining momentum in developing countries, understanding the impacts of payment-system development on the real economy becomes essential. In this paper, we exploit India's demonetization shock to estimate the degree of payment-system development in India and rely on a structural model to identify the impacts of payment systems on supporting short-run economic stability and long-run economic development in emerging economies. We find that payment systems stabilize the real economy and absorb adverse shocks in the short run. However, payment-system development does not always translate into long-run economic growth. Instead, the effect relies on the cash-consumption relation in the economy. In particular, in the case of a complementary (substitutional) cash-consumption relationship, payment-system development reduces (increases) real output and impedes (promotes) economic growth