Digital Payments Induce Over-Spending: Evidence from the 2016 Demonetization in India

We examine the impact of digital payments on consumer spending by exploiting a forced switch to digital payments induced by the 2016 Indian Demonetization. This policy resulted in a 86% decline in the cash that could be used for spending transactions and led cash-dependent consumers to adopt digital payments. We find that an increase of 10 percentage points in prior cash dependence increases usage of digital payments by 3.24 percentage points and monthly spending by 3%. Usage of digital payments and spending remain elevated when cash availability is replenished. The increase in spending comes from purchasing expensive products in narrowly-defined categories and using promotional offers less, and is not driven by income shock, credit supply, suppliers’ pricing response, or consumers’ moving to the formal market. These results highlight that digital payments can induce over-spending due to their subdued salience and shed light on the policy debate about the costs and benefits of moving to a cashless economy.