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A SVAR approach to evaluation of monetary policy in India

William Barnett (), Soumya Suvra Bhadury and Taniya Ghosh ()
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Soumya Suvra Bhadury: University of Kansas

Indira Gandhi Institute of Development Research, Mumbai Working Papers from Indira Gandhi Institute of Development Research, Mumbai, India

Abstract: After almost 15 years, following the flagship exchange-rate paper written by Kim and Roubini (K&R henceforth); we revisit the widely relevant questions on monetary policy, exchange rate delayed overshooting, inflationary puzzle and weak monetary transmission mechanism in the Indian context. We further try to incorporate a superior form of the monetary measure called the Divisia monetary aggregate in the K&R setup. Our paper still rediscovers the efficacy of K&R contemporaneous restriction (customized for the Indian economy which is a developing G-20 nation unlike advanced G-6 nations that K&R worked with) especially when we compared with the recursive structure (which is plagued by price puzzle and exchange rate puzzle). The importance of bringing back 'Money' in the exchange rate model especially correctly measured monetary aggregate is convincingly illustrated when we contested across models with no-money, simple-sum monetary models and Divisia monetary models; in terms of impulse response (eliminating some of the persistent puzzles), variance decomposition analysis (policy variable explaining more of the exchange rate fluctuation) and out-of-sample forecasting (LER forecasting graph). Further, we do a flip-flop variance decomposition analysis, which leads us to conclude two important phenomena in the Indian economy, (i) weak link between the nominal-policy variable and the real-economic activity (ii) Indian monetary authority had inflation-targeting as one of their primary goals, in tune with the RBI Act. These two main results are robust, holding across different time period, dissimilar monetary aggregates and diverse exogenous model setups.

Keywords: Monetary Policy; Monetary Aggregates; Divisia; Structural VAR; Exchange Rate Overshooting; Liquidity Puzzle; Price Puzzle; Exchange Rate Puzzle; Forward Discount Bias Puzzle (search for similar items in EconPapers)
JEL-codes: C32 E41 E51 E52 F31 F41 F47 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2015-06
New Economics Papers: this item is included in nep-cba, nep-for, nep-mac and nep-mon
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