Perverse liquidity effect of monetary policy: some evidence for India
Sridhar Telidevara and
Debashis Acharya ()
Macroeconomics and Finance in Emerging Market Economies, 2014, vol. 7, issue 1, 61-82
The liquidity effect of money supply increases, as policy-oriented measures, would generally lead to a decline in interest rates. This is the direct effect. However, such money supply increases lead to a sum of the direct effect plus the positive indirect price and income effects. In sum, the net effect may be positive leading to a net increase and not a decrease in the interest rate. The regular money demand function is suitably modified to capture the structural changes of the Indian economy to verify the net effect of monetary policy-induced money supply movements. The empirical evidence indicates the presence of a perverse liquidity effect.
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