Effectiveness of Monetary Policy Transmission in Small Open Economy: An Empirical Exploration on India

Samahita Phul ()
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Samahita Phul: Jawahar Lal Nehru University (JNU)

Journal of Quantitative Economics, 2025, vol. 23, issue 2, No 8, 560 pages

Abstract: Abstract This study examines the effects of monetary policy shocks in India during two distinct monetary policy regimes- Multiple Indicator Targeting Regime (2001–2016) and the Flexible Inflation Targeting regime (2016–2023) using Structural Vector Autoregressive models. We achieve identification by imposing three sets of identification restrictions. i.e. theoretically plausible non-recursive identification restrictions on the structural coefficients, Sign-based restrictions on the Impulse response functions and Sign and zero restrictions on the systematic component of monetary policy. The results obtained from a non-recursively identified SVAR provide plausible responses of macroeconomic variables to a monetary policy shock. The responses obtained from Sign based restrictions reveal evidence of money neutrality during both the regimes. Moreover, these restrictions do not rule out positive price responses for the horizon under analysis. Nonetheless, when we impose regime specific sign and zero restriction on the structural coefficients in the the monetary policy reaction function, the monetary policy transmission appears to be weak during both the regimes. Notwithstanding this within a non-recursive SVAR, we find Interest rate channel to be potent in influencing real economic variables during both the regimes. Overall, the imposition of sign and zero restrictions does not prove informative in deciphering the effects of monetary policy in India. This suggests that either the monetary policy reaction function has not been successfully identified or the monetary policy transmission is rather weak in India. Future research should thus continue to search for more credible identifying restrictions that produce plausible estimates of macroeconomic variables in response to a monetary policy shock.

Keywords: SVARs; Monetary policy shocks; Systematic component of monetary policy; Monetary policy effectiveness; Transmission channels; Shutdown methodology; Flexible Inflation Targeting Regime (search for similar items in EconPapers)
JEL-codes: C32 E5 E52 F41 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s40953-024-00438-2

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