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Effectiveness of expectations channel of monetary policy transmission: Evidence from India

Ashima Goyal and Prashant Parab ()
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Prashant Parab: Indira Gandhi Institute of Development Research

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

Abstract: We examine the efficacy of expectations channel of monetary policy transmission in India using survey-based expectations of households and professional forecasters in a Structural Vector Auto Regression (SVAR) framework. To analyse the fixed point between inflation and inflation expectations, we estimate how expectations shocks feed into the dynamics of macroeconomic aggregates. Second, we find the shocks affecting these expectations. Third, we estimate shocks influencing core inflation. SPF expectations shocks affect headline and food inflation and RBI projections. Petrol price shocks, RBI projection shocks and supply shocks (headline inflation) affect household inflation expectations. Food inflation affects expectations in the short run while core inflation has long-run influence. 3-month-ahead SPF forecasts are influenced by supply-side shocks, monetary policy shocks and RBI projections. Results are robust to alternative identifications. In the early years of flexible inflation targeting that we cover the main interaction was between SPF forecasts and RBI projections on to core. The fixed point was stable because the response of each variable was less than unity. The evidence indicates the expectations channel of transmission was more effective than the aggregate demand channel.

Keywords: Household expectations; Survey of professional forecasters; Central bank communications; Expectations channel; Structural vector auto regression (search for similar items in EconPapers)
JEL-codes: D83 D84 E52 E58 (search for similar items in EconPapers)
Pages: 41 pages
Date: 2021-04
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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