THE IMPACT OF MONETARY POLICY ON OUTPUT AND INFLATION IN INDIA: A FREQUENCY DOMAIN ANALYSIS

Bhavesh Salunkhe and Anuradha Patnaik

Economic Annals, 2017, vol. 62, issue 212, 113 - 154

Abstract: In the recent past, several attempts by the RBI to control inflation through tight monetary policy have ended up slowing the growth process, thereby provoking prolonged discussion among academics and policymakers about the efficacy of monetary policy in India. Against this backdrop, the present study attempts to estimate the causal relationship between monetary policy and its final objectives; i.e., growth, and controlling inflation in India. The methodological tool used is testing for Granger Causality in the frequency domain as developed by Lemmens et al. (2008), and monetary policy has been proxied by the weighted average call money rate. In view of the fact that output gap is one of the determinants of future inflation, an attempt has also been made to study the causal relationship between output gap and inflation. The results of empirical estimation show a bi-directional causality between policy rate and inflation and between policy rate and output, which implies that the monetary authorities in India were equally concerned about inflation and output growth when determining policy. Furthermore, any attempt to control inflation affects output with the same or even greater magnitude than inflation, thereby damaging the growth process. The relationship between output gap and inflation was found to be positive, as reported in earlier studies for India. Furthermore, the output gap causes inflation only in the short-tomedium-run.

Keywords: Granger Causality; Frequency Domain; Monetary Policy; Output Gap. (search for similar items in EconPapers)
JEL-codes: C32 E52 E58 (search for similar items in EconPapers)
Date: 2017
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