


































DEM_2019_41to56


© 2019 Nicolaus Copernicus University. All rights reserved.  
http://www.dem.umk.pl/dem 

D Y N A M I C  E C O N O M E T R I C  M O D E L S  
DOI: http://dx.doi.org/10.12775/DEM.2019.003  Vol. 19 (2019) 41−56 

Submitted July 3, 2019  ISSN (online) 2450-7067 
Accepted December 20, 2019 ISSN (print) 1234-3862 

Sebastian A. Roy * 

Demonetisation as an Economic Policy Tool: 
Macroeconomic Implications of a Monetary Market 

Shock. The Example of the Indian Monetary Reform 

A b s t r a c t. This paper discusses the implementation of the 2016 India demonetisation, and 
analyses its macroeconomic consequences. The pivotal issue here is a regional heterogeneity 
of CPI inflation caused by demonetisation. A dynamic panel CPI model has been estimated in 
order to find out whether unequal accessibility of banking services determines the inflation 
heterogeneity. The findings suggest that financial services accessibility is not a significant in-
flation-driving factor. Hence a hypothesis about a redistribution of wealth between rural and 
urban areas with different access to banking might be rejected. 

K e y w o r d s: developing economies; inflation; macroeconomic policy; monetary policy; 
panel econometrics. 

J E L Classification: E02, E26, E31, E52; C01, C23 

Introduction 
 Demonetisation in India was announced on 8 November 2016 and in-
cluded pulling from circulation banknotes of the two highest denominations 
(500 INR and 1,000 INR). Subsequently, new series of 500 INR and 2,000 
INR notes were issued, but in order to exchange the old notes it was required 
to make a bank account deposit (Killawala, 2016b). According to OECD, the 

 
* Correspondence to: Sebastian A. Roy, SGH Warsaw School of Economics, Kazimierza 

Promyka 5/80, 01-604 Warszawa, e-mail: sebastian.amit.roy@gmail.com 
 



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42 

demonetised notes composed 86% of cash in circulation (Beyes and 
Bhattacharya, 2017). 
 The demonetisation was designed to achieve four goals: curbing black 
economy, tackling bribery, targeting counterfeit notes, and cutting resources 
of terrorist organisations (Modi, 2017). Such a selection of aims implies that 
the demonetisation needs to be analysed not only in its economic dimension, 
but also in a social one. 
 Whatever its political and institutional motivations, Indian monetary re-
form remains a macroeconomic experiment of substantial interest, perhaps the 
most sweeping change in currency policy that has occurred anywhere in the 
world in decades, according to the former US treasury secretary Lawrence 
Summers (Sharma, 2016). It is worth noting that experiment is scarcely used 
in macroeconomic research – this is due to the fact that hardly would anybody 
allow economists to wreak havoc in lives of millions for sake of their curiosity 
(Czarny, 2017). Moreover, the demonetisation may be considered as a ceteris 
paribus negative shock in the M1 money supply, since it was introduced in 
times of solid economic growth and in a stable political environment. This 
allows usage of the post-demonetisation macroeconomic data in empirical 
studies of price flexibility in emerging markets and inflation-driving factors. 
 Demonetisation has received limited interest from the researchers. First 
analyses, most of them penned by economic journalists, were published in 
December 2016 by media such as The Economist (2016), Forbes (Worstall, 
2016), and Al Jazeera (Sharma, 2016). They were followed by a number of 
speculative papers published by mostly Indian think-tanks and universities. 
Their common characteristic was, however, lack of empirical evidence for 
discussed hypotheses – none of them employed formal statistical inference in 
order to support authors’ reasoning, except for the paper by Chodorow-Reich, 
Gopinath, Mishra et al. (2018). In Polish literature demonetisation has at-
tracted even weaker attention. In December 2016 the issue was examined in 
Monitoring Makroekonomiczny (Roy, 2016). 
 This paper aims at discussing implementation of the 2016 Indian demon-
etisation and its macroeconomic consequences. In the first section it presents 
a detailed analysis of the reform implementation process, based on the author-
ities’ announcements. The second section aims to analyse possible macroeco-
nomic consequences of driving 86% of cash out of the circulation. It com-
prises an empirical study alongside with a broad discussion of the literature. 
The key hypothesis here is presence of a regional heterogeneity of CPI infla-
tion caused by demonetisation. A dynamic, individual effects CPI model has 
been estimated in order to find out whether unequal accessibility of banking 
services determines the inflation heterogeneity. Moreover, the analysis also 



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43 

discusses the reform’s possible impacts on GDP and the role of elasticities in 
shaping the real sector response to a nominal shock. 
 The CPI heterogeneity research is based on a panel dataset of monthly 
observations for 35 Indian states with distinction between rural and urban ar-
eas in the post-demonetisation period. Estimates show that a hypothesis of 
a positive short-run correlation between banking accessibility and CPI growth 
rates can be rejected under all circumstances. Hence unequal accessibility of 
banking services couldn’t have driven cross-sectional CPI inflation variability 
following demonetisation.  

1. Implementation of the Demonetisation 

1.1. Primary Demonetisation Mechanism 
 The earliest source of information about the technical details of the pro-
cess of withdrawing and exchanging the old notes was an address by the PM 
Narendra Modi broadcasted on 8 November 2016. More formally, demoneti-
zation was scheduled by two Reserve Bank of India (RBI) statements (Vijaya 
Kumar, 2016a; Dave, 2016). Later some elements of the reform were cor-
rected and adjusted in response to certain difficulties arising. The first demon-
etization schedule comprised the following points (Modi, 2017): 
1. Owners of the old 500 INR and 1,000 INR notes may deposit them at 

a bank or post office from 10 November to 30 December 2016 with no 
limitations. 

2. Cash withdrawals from bank accounts shall not exceed 10,000 INR per 
day and 20,000 INR per week. The limit is to be relaxed in a short time. 

3. Over-the-counter notes exchange for immediate needs is possible at every 
bank or post office. Such an exchange is limited to 4,000 INR. After 24 
December the limit shall be increased1. 

4. Any person unable to exchange their old notes before 30 December 2016 
may do the exchange at certain RBI branches before 31 March 2017. 

5. On 9 December 2016 (in particular cases, on 10 December as well) ATMs 
shall be shut due to recalibration. After recalibration cash withdrawals 
are limited to 2,000 INR per card. The limit shall be increased to 4,000 
INR in a short time. 

6. Cashless transactions via cheques or electronic transfers may be con-
ducted with no restrictions. 

 
1 Eventually the limit was not changed. On 24 November 2016 RBI decided to end the 

OTC exchanges (Beyes and Bhattacharya, 2017). 



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7. Due to convenience and humanitarian reasons the following units will 
accept payments made in the old notes within 72 hours from the an-
nouncement of the demonetization: 
a. Public hospitals and drug stores located therein (only for medicines 

prescribed by a physician) 
b. Bus, train and flight ticket booking points 
c. Petrol stations authorised by the national oil companies 
d. Consumer cooperative stores authorized by the state or central gov-

ernment 
e. Milk booths authorized by the state authorities 
f. Burial grounds and crematoria 
g. Currency exchange offices at international airports 

 The vital part of the demonetisation policy, designed to tackle bribery and 
black economy, was obligatory fiscal investigation of every newly created 
bank deposit of 250,000 INR or more (Roy, 2016). Failure in proving that the 
due tax had been payed could end up with being fined 200% of the overdue 
fiscal liabilities (Rowlatt, 2016). 

1.2. Modifications of the Demonetisation Mechanism 
 The primary organization of the reform was subject to multiple alterations 
after 8 November 2016. Due to a significant number of modifications OECD 
experts Peter Beyes and Reema Bhattacharya described Indian demonetisation 
as evolutionary (Beyes and Bhattacharya, 2017). According to their research, 
in the central period of the reform (that is from 8 November to 30 December 
2016) RBI issued 50 announcements concerning demonetisation, majority of 
whose significantly modified its implementation. On the other hand, Ministry 
of Finance issued 19 such announcements, part of which actually mirrored 
those produced by the RBI. 
 The most important modifications of the reform concerned means of de-
positing and exchanging old notes as well as limits of cash withdrawals. Those 
were issues of outstanding significance for the rural areas inhabitants. Cash 
shortages posed a serious threat to farmers who could not pay for seeds for 
winter sowing. 
 On 14 November 2016 RBI decided to withdraw the right to exchange2 
notes from two most popular rural financial institutions, District Central Co-
operative Bank (DCCB) and Primary Agricultural Credit Society (PACS) (Vi-
jaya Kumar, 2016c). RBI decision was founded on a suspicion that DCCB and 

 
2 Those institutions were no more allowed to deposit old notes. 



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PACS were used for money laundering, as between 8 and 14 November 2016 
they noted outstandingly high inflow of cash (Beyes and Bhattacharya, 2017). 
As a result, accessibility to the banking services was seriously restrained in 
the rural areas, whose inhabitants had to commute to towns or cities in order 
to exchange their notes. 
 Demonetisation timing further exacerbated circumstances for the agricul-
tural sector. In November Indian farmers harvest their summer crops and sow 
winter seeds. Free access to financial services is of utmost importance as it 
allows for depositing resources obtained from summer crops sales and pro-
vides funding for sowing seeds. Therefore, RBI decision concerning DCCB 
and PACS met strong resistance. In response to the social distress, on 20 No-
vember 2016 farmers were allowed to purchase seed with old banknotes 
(Dhoot, 2016). Moreover, on 21 November RBI raised the cash withdrawal 
limit to 25,000 INR for farmers (Vijaya Kumar, 2016b). 

2. Macroeconomic Consequences of the Reform 

2.1. Literature Review 
 The literature discussing demonetisation in India comprises two groups of 
articles. First set contains articles published in various economic magazines 
shortly after the reform had been announced. Among them three deserve spe-
cial interest. The first, authored by White and Rajagopalan (2016) from Foun-
dation for Economic Education (FEE), discusses selected issues of remoneti-
sation, including seigniorage; second, by Forbes’ Worstall (2016), provides 
one of the earliest discussions of the impact demonetisation might have on 
GDP growth; the third, by The Economist (2016), analyses social impact of 
the reform. The second set comprises research papers covering multivariate 
issues of the demonetisation. 
 In a Keynesian-inspired paper Impact of Demonetisation on India: 
a Macro-theoretic Analysis A. Ghosh (2017) develops a disaggregated de-
mand model with two sectors: organised and unorganised. The unorganised 
sector uses organised sector output as the only input and produces goods that 
have perfectly flexible prices. Due to illiteracy and restricted access to collat-
eral, the unorganised sector settles all transactions in cash, hence it must pos-
ess certain cash holdings. On the other hand, the organised sector is an oligop-
oly that uses two inputs: capital and labour. There are markups on wages and 
capital rental rates, with short-run wages constant. The organised sector may 
be considered cashless except for transactions with the unorganised sector. 



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 Ghosh uses his model to determine possible impact of demonetisation on 
the Indian economic growth, but his findings are ambiguous. Cash supply 
slump may lower production of the unorganised sector, which in turn should 
make the organised sector output decrease – all in all, total production shall 
fall. On the other hand, lower cash supply could increase demand for the goods 
produced in the organised sector, thus boosting GDP. However, Ghosh argues 
that such a demand shift shall be limited due to low accessibility of the organ-
ised sector output in less affluent areas and reluctance towards cashless pay-
ments. 
 One of the earliest macroeconomic papers on the monetary reform is the 
one by the National Institute of Public Finance and Policy (NIPFP) from 14 
November 2016 (Rao, Mukherjee, Kumar et al., 2016). It provides an analysis 
of short- and medium-run effects of the negative money supply shock based 
on four types of transaction demand for cash. Those include accounted trans-
actions, unaccounted transactions, informal sector transactions, and illegal 
transactions. Furthermore, it includes credit supply and public finance issues. 
 In the short-run the report predicts a sharp fall in households’ income and 
consumption due to a plunge in money supply. Similarly, to Ghosh (2017), 
the NIPFP experts suggest that the informal sector might be affected stronger 
than the formal one. Interestingly, they oppose a common notion that the re-
form will induce CPI deflation. Contrarily – if cash shortage makes firms pro-
duce less, prices may even rise. Finally, demand of those who do not have 
access to digital payment methods shall decrease, thus lowering the aggregate 
demand. 
 In the medium-run Rao, Mukherjee, Kumar, et al. stress that impact of the 
reform will depend on the remonetisation scale. If the authorities manage to 
conduct remonetisation swiftly3, effects should be mild and scarce. However, 
there are several sectors with high probability of being affected, including ag-
riculture and construction. The report notes also a possible positive effect that 
growing deposits may have on the credit supply and, eventually, on the whole 
economy. 
 Das and Rawat (2017) from Institute for Studies in Industrial Development 
(ISID) evaluate demonetisation’s performance against its intended targets 
alongside discussing it from a GDP growth perspective. Their conclusions are 
pessimistic. They find that the reform’s efficiency in fighting black economy 
and counterfeit currency is too low to outweigh macroeconomic threats it 

 
3 That is, if remonetisation does not exceed two months (Rao, Mukherjee, Kumar et al., 

2016). 



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poses. Moreover, they interpret early post-demonetisation macroeconomic in-
dicators as disappointing. 
 Siddiqui, Mishra and Tiwari (2017) present an analysis including fiscal 
consequences of the demonetisation. They suggest that allowing for paying 
taxes in demonetised notes might be a strong incentive for quicker and more 
comprehensive filling for tax return. After examining Ministry of Finance fis-
cal data, they argue that the fiscal authorities noted a 260% rise in municipal 
and local tax payments within 14 days from demonetisation. 

2.2. Regional Heterogeneity of Inflation. Price Arbitrage Hypothesis 
 Interestingly, issue of post-demonetisation regional diversity of prices is 
not discussed in the literature except for the paper by White and Rajagopalan 
(2016). Arguably, unequal access to financial services could contribute to 
cross-sectional deflation heterogeneity. 
 In the process of exchanging old notes commercial banks played a crucial 
role. This could lead to regional differentiation in remonetisation dynamics, 
conditional on local accessibility to financial services. Arguably, M1 money 
supply in the rural areas with poorer access to banks might have been lower 
than in urban localities, where financial institutions were better accessible, 
particularly given restrictions on DCCB and PACS (Vijaya Kumar, 2016c). 
 According to the Keynesian aggregated demand framework, prices are 
sticky in the short-run (Czarny, 2017). This assumption has a robust justifica-
tion; indeed, there is a wide consensus among economists that flexible price 
assumptions of the quantity theory of money are not satisfied but in a long-
run analysis (Sławiński, 2011). However, Indian economy is heavily cash-de-
pendent as 90% of all transactions there are settled in cash (Beyes and 
Bhattacharya, 2017). Hence in the Indian case of an abrupt demonetisation of 
86% of cash in circulation prices can be flexible even in the short-run. It is 
worth noting that Ghosh (2017) reaches a similar conclusion while specifying 
his macro-theoretic model. Summing up, it is justified to expect that in the 
areas with high banking accessibility slump in the M1 money supply was 
milder, thus dampening change of prices. Specifically, CPI deflation could be 
deeper in poorer states, but also there could occur within-state price index het-
erogeneity between rural and urban areas. 
 Unlike international price differentiation, neither within- nor between-
state CPI heterogeneities could not be neutralized through the exchange rate 
as INR is a legal tender in the whole Indian territory. Hence temporary or 
persistent purchasing power diversity could be employed in a following arbi-
trage scheme: 



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1. Capital transfer to the locality with higher purchasing power (equiva-
lently, with deeper deflation) 

2. Purchase of goods at lower prices 
3. Shipping the goods back to the area with lower purchasing power (equiv-

alently, with milder deflation) 
4. Selling the goods with profit 

 Arbitrage results with a wealth transfer from regions suffering from 
deeper deflation to those with higher prices. Since CPI dynamics depends on 
financial services accessibility, which is higher in more affluent, often urban-
ised regions, post-demonetisation arbitrage could lead to deepening economic 
inequalities in India. This effect could be further amplified by the fact that 
business entities from the wealthy regions were able to take advantage of their 
well-developed distribution networks. 
 Nonetheless; conducting such an arbitrage scheme would pose multiple 
difficulties, e.g. in specifying goods whose prices differ regionally. Tackling 
it in detail would require scrutinizing trade flows in India, which falls beyond 
scope of this paper. Therefore the empirical study presented in the final chap-
ter discusses regional price heterogeneity only, leaving aside question of 
whether arbitrage actually took place. 

2.3. Real Economy Response to the Money Supply Shock. Nominal 
Rigidities and Shift of the Long-run AS Curve (LAS) 

 Demonetisation impact on the GDP has been widely discussed since the 
very first days of the reform, with the earliest paper tackling this issue being 
that of Rao, Mukherjee, Kumar et al. (2016) published five days from the re-
form commencement. While there is a broad consensus that in the short run 
consumption (and consequently aggregated demand) shrank, opinions about 
demonetisation’s long-run impact on the real economy vary significantly. This 
chapter studies long-run response of the real sector to the money supply shock, 
paying particular attention to the possibility of a long-run AS curve shift 
caused by a substantial shrink in the money supply. 



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Figure 1. AD-AS model 

 Real economy analysis will be founded on the AD-AS framework (com-
pare Czarny, 2017). In AD-AS model economy reaches equilibrium at the in-
tersection of negative aggregated demand (AD) curve, flat and positive short-
run aggregated supply (SAS) curve and vertical long-run aggregated supply 
(SAS) curve. In the Fig. 1 equilibrium is denoted as E. Under AD-AS ap-
proach a money supply slump is a negative demand shock, which shifts the 
demand from AD to AD’. Hence temporary equilibrium is reached at the point 
E’, where AD’ and SAS intersect. The temporary equilibrium is characterized 
with slightly lower prices and substantially decreased output. In the long run, 
however, SAS curve shifts downward and a new equilibrium E’’ is reached 
with the pre-shock level of output, but lower prices. This illustrates that in the 
long run money the real sector is independent from nominal shocks. 
 The AD-AS analysis above could be summarized in a following way: 
a demonetisation-caused negative demand shock in the short run lowers the 
output due to nominal rigidities. After certain adjustments, the economy 
reaches new equilibrium with potential output and lower prices. That means 
that in the long run a negative demand shock affects the nominal economy 
only. 
 There are two assumptions in the AD-AS approach that deserve special 
scrutiny. The first is: were prices in India actually sticky in the post-demone-
tisation period? Price stickiness is a crucial assumption for the AD-AS analy-



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50 

sis. There is massive literature covering the nominal rigidity issue, both theo-
retical, such as Burda and Wyplosz (2012), Begg, Fischer, Vernasca et al. 
(2014), Czarny (2017), and empirical, e.g. Banerjee and Bhattacharya (2017), 
Chong, Zhu and Rafiq (2013); it is also in line with assumptions of the bench-
mark demonetisation research made by Chodorow-Reich, Gopinath, Mishra 
et al. (2018). However, is it justified to assume that after such a dramatic de-
mand shock as demonetisation of 86% of cash in circulation, prices remained 
sticky? 
 On the one hand, it is reasonable to suspect that about 7 times higher de-
crease of cash supply in an economy with approx. 100% of all transactions 
volume and 70% of their value settled in cash should cause a fall in CPI. On 
the other hand, remonetisation started immediately after the reform was an-
nounced, which could limit its effect on inflation. 
 Price stickiness assumption may be verified empirically with a time series 
analysis. Figure 2 shows the Reserve Bank of India (RBI) data about year-on-
year CPI inflation and year-on-year M1 money growth rate. According to the 
data there is no ground for rejection of the short-run price stickiness hypothe-
sis. Within two quarters from the beginning of the reform there occurred 
a slight CPI deflation; nevertheless, negative price dynamics not exceeding 5 
percentage points do not differ significantly from its pre-demonetisation lev-
els. 

 
Figure 2. Inflation and M1 money supply dynamics 

-0,3

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Inflation M1 money supply dynamics (right axis)



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 The second AD-AS model assumption that needs to be re-considered, is 
constant potential output or, in other words, issue whether LAS curve is fixed. 
Standard justification for this assumption says that the potential output de-
pends solely supply-driven, depending only on technology and means of pro-
duction. 
 Constant potential output assumption may be true only if hardships caused 
by demonetisation did not result with substantial number of insolvencies be-
tween Indian business entities. Among them small enterprises which generally 
settle in cash and have limited access to credit4, could be affected in a stronger 
way. Hence long run demonetisation impact on the aggregated supply should 
depend on general market flexibility. If entrepreneurs failed to display enough 
perseverance to operate under cash shortages and became insolvent, decrease 
in potential output should be expected. Such a wave of insolvencies would 
directly result with persistent decrease of different types of capital: physical 
(machines in the case of craftsmen, vehicles in the case of rickshaw drivers), 
human (know-how) and institutional (cutting employer-employee relations). 
 There is empirical, macroeconomic evidence that in the months following 
demonetisation the number of bankruptcies among small entrepreneurs actu-
ally rose (Shirley, 2017). RBI negatively corrected the MPC5 forecasts of GDP 
growth for the 2016-17 accounting year. They were adjusted from 7.6% on 4 
October 2016 (Killawala, 2016a) to 6.9% on 8 February 2017 (Killawala, 
2017). Multiple international organisations lowered their forecasts as well. 
 The data presented below imply that the demonetisation impact on the 
GDP growth was only temporary, which supports the thesis that there was no 
shift of the LAS curve. However, post-demonetisation estimation of the po-
tential product of the Indian economy remains a promising field of research. 

Table 1. GDP growth forecasts 

Institution WB IMF CMIE ICRA Fitch 
Pre-demonetisation growth forecast [%] 7.6 7.6 7,.5 7.7 7.4 

Post-demonetisation forecast [%] 7.0 6.6 6.0 6.8 6.9 
Forecast change [p. points] –0.6 –1.0 –1.5 –0.9 –0.5 

Note: WB – World Bank, IMF – International Monetary Fund, CMIE – Centre for Monitoring of Indian 
Economy, ICRA – Investment Information and Credit Rating Agency of India Ltd. 

 
4 This is partially justified by Ghosh, who says that producers and workers in the unor-

ganized sector cannot access institutional financial facilities because of illiteracy and lack of 
collateral (2017). 

5 Monetary Policy Committee of India. 



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3. Dynamic Panel CPI Model 

3.1. Research Hypotheses 
 A dynamic panel CPI model has been developed in order to verify hypoth-
esis of regional heterogeneity of inflation driven by unequal access to financial 
services. Formally, methods of statistical inference have been used to study 
the following hypotheses: 
H1: banking accessibility is a positive, statistically significant inflation-driv-

ing factor 
H2: banking accessibility has a stronger impact on inflation in rural territories 

 Estimation was computed in R software using plm package (Croissant and 
Millo, 2008). 

3.2. The Data 
 The model employs a panel dataset of monthly observations for 35 Indian 
states with distinction between rural and urban areas in the post-demonetisa-
tion period. The data has been downloaded from Database on Indian Economy 
(DBIE) governed by the RBI and from the Census 20116 database. Observa-
tions for the state of Telangana have been dropped due to missing demo-
graphic data. All the variables are discussed in detail in Table 2. 

3.3. Model Specification. Discussion of the Method. 
 Hypotheses presented in 3.1 have been verified with three dynamic panel 
CPI models with fixed effects, estimated separately for rural, urban and ag-
gregate inflation. Such a specification is able to account for cross-sectional 
heterogeneity and inflation time-persistence. Detailed specification is given 
below: 

𝑖𝑛𝑓!" = 𝛽#𝑖𝑛𝑓!,"%# + 𝛽&𝑑𝑦𝑛𝑀1" + 𝛽'𝑏𝑎𝑛𝑘𝑖𝑛𝑔𝑃𝐶!" + 𝜇! + 𝜀!" 
𝑅𝑖𝑛𝑓!" = 𝛽#𝑅𝑖𝑛𝑓!,"%# + 𝛽&𝑑𝑦𝑛𝑀1" + 𝛽'𝑅𝑏𝑎𝑛𝑘𝑖𝑛𝑔𝑃𝐶!" + 𝜇! + 𝜀!" 
𝑈𝑖𝑛𝑓!" = 𝛽#𝑈𝑖𝑛𝑓!,"%# + 𝛽&𝑑𝑦𝑛𝑀1" + 𝛽'𝑈𝑏𝑎𝑛𝑘𝑖𝑛𝑔𝑃𝐶!" + 𝜇! + 𝜀!" 

 Coefficients have been estimated with Arellano and Bond (1991) estima-
tor. 
  

 
6 Between 2011 and 2016 no Census survey had been conducted. 



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Table 2. Dataset description 
Variable Description Type Source Comments 

Rinf CPI yoy inflation rate at rural areas [%] Panel, monthly DBIE 
RBI  

Uinf CPI yoy inflation rate at urban areas [%] Panel, monthly DBIE 
RBI  

inf CPI yoy inflation rate [%] Panel, monthly DBIE 
RBI  

dynM1 M1 money supply yoy growth rate [%] Time series, 
monthly 

DBIE 
RBI 

Own calcula-
tions 

Rbranches Number of commercial bank branches at 
rural areas Panel, quarterly DBIE 

RBI  

Ubranches Number of commercial bank branches at 
urban areas Panel, quarterly DBIE 

RBI  

Mbranches Number of commercial bank branches at 
metropolitan areas Panel, quarterly DBIE 

RBI  

branches Total number of commercial bank 
branches Panel, quarterly DBIE 

RBI 
Own calcula-

tions 
Rpopulation Rural population Cross-section Census  
Upopulation Urban population Cross-section Census  
Population Total population Cross-section Census  

RbankingPC Banking accessibility coefficient at rural ar-
eas7 Panel, quarterly  Own calcula-

tions 

UbankingPC Banking accessibility coefficient at urban 
areas8 Panel, quarterly  Own calcula-

tions 

bankingPC Total banking accessibility coefficient Panel, quarterly  Own calcula-
tions 

3.4. Regression Analysis 
 Table 3 presents the estimates with selected post-estimation statistics9. 
Due to strong second-order autocorrelation of the residuals, robust variance-
covariance matrix is used. All the tests assume standard 5% significance level. 
 Each panel is balanced. Aggregate inflation panel is of width n=35 and 
length T=12 with N=420 observations altogether, out of which 338 are used 
in estimation. Rural inflation panel is of width n=35 and length T=12 with 
N=420 observations altogether, out of which 348 are used in estimation. Ur-
ban inflation panel is of width n=35 and length T=12 with N=420 observations 

 
7 Coefficient calculated as a fraction of number of bank branches at particular area over its 

population. 
8 Metropolitan areas will be treated as a subset of urban territories, hence 𝑈𝑏𝑎𝑛𝑘𝑖𝑛𝑔𝑃𝐶 =

!"#$%&'()*+"#$%&'()
!,-,./$01-%

. 
9 P-values for statistical tests are given in brackets. 



Sebastian A. Roy 

DYNAMIC ECONOMETRIC MODELS 19 (2019) 41–56 

54 

altogether, out of which 340 is used in estimation. Differences in sample sizes 
are due to the missing values structure. 

Table 3. Estimation summary 
Dependent 

variable 𝜷𝟏 𝜷𝟐 𝜷𝟑 Wald chi-squared 
statistic 

Arellano-Bond 2nd order 
correlation test 

𝒊𝒏𝒇 0.86 
(0) 

2.47 
(0) 

39,700 
(0.35) 416.793 (0) -2.5 (0.01) 

𝑹𝒊𝒏𝒇 0.89 
(0) 

2.72 
(0) 

46,496 
(0.58) 153.673 (0) -2.55 (0.01) 

𝑼𝒊𝒏𝒇 0.74 
(0) 

3.28 
(0) 

117,360 
(0.18) 420.943 (0) -1.24 (0.22) 

 Each model tested with Wald chi-squared statistic is statistically signifi-
cant. Autoregressive part of each model is also significant. Rural inflation 
proves to be the most persistent with adjacent coefficient taking value of 0.89. 
Money supply dynamics is also a significant, positive factor shaping inflation. 
Its impact is strongest in the urban areas, where money supply growth by 1 
percentage points rises inflation by 3.28 percentage points. 
 Banking accessibility, however, turns to be uncorrelated with CPI infla-
tion. Its coefficients are statistically insignificant with p-values of 0.18 for the 
urban, 0.58 for the rural and 0.35 for the aggregate panel.  
 It is noteworthy that the urban panel is the only one in which no autocor-
relation null hypothesis in the second-order Arellano-Bond test cannot be re-
jected. This suggests that standard variance-covariance matrix can be used in-
stead of the robust one. Under standard variance-covariance matrix banking 
accessibility becomes significant with p-value close to zero. However, since 
robust standard errors account not only for autocorrelation, but also other 
types of non-spherical variance-covariance matrix, conclusions shall be drawn 
in accordance to the robust error estimates. 

Conclusions 
 Empirical study shows that both H1 and H2 hypotheses stated in subsec-
tion 3.1 can be rejected. Banking accessibility proves not to be a significant 
inflation-shaping factor; therefore, one cannot say that its impact is stronger 
in the rural areas. This is a strong argument in support of a thesis that citizens 
of India did not face difficulties connected to unequal access to the financial 
institutions. 
 Lack of correlation between banking accessibility and inflation cannot 
verify whether restrictions imposed by the RBI on DCCB and PACS did not 
influence prices significantly. This is so because DCCB and PACS counted 



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