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Monetary Transmission Mechanism in India: A Quarterly Model

Muneesh Kapur and Harendra Behera

MPRA Paper from University Library of Munich, Germany

Abstract: This paper examines monetary transmission mechanism for India in the context of a small macro model using quarterly data. Given the volatility emanating from the agricultural sector, the paper models both overall growth and overall inflation as well as non-agricultural growth and non-food manufactured products inflation, i.e., components stripped of the influence from the agricultural sector and which are more amenable to monetary actions. Model simulations for a one-quarter 100 bps increase in the nominal effective policy rate show that the peak effect on non-agricultural growth is almost 40 bps with a lag of 2 quarters and that on non-food manufactured products inflation is 25 bps with a lag of 5 quarters. Therefore, the interest rate channel is effective in the Indian context and the magnitude of the impact on growth and inflation is comparable to that in major advanced and emerging economies; however, the evidence for both India and other countries suggest that the impact of monetary policy actions on inflation is modest and subject to lags. The results are sensitive to alternative measures of real interest rate. Despite the monetary tightening by Reserve Bank of India during 2010 and 2011, inflation remained high and this could be attributed to the structural component of food inflation as well as the surge in international commodity prices beginning the second half of 2010 and continuing into the first half of 2011.

Keywords: Exchange Rate Pass-through; India; Monetary Policy; Monetary Policy Reaction Function; Monetary Transmission; Neutral Interest Rate; Phillips Curve (search for similar items in EconPapers)
JEL-codes: E31 E32 E52 E58 F41 (search for similar items in EconPapers)
Date: 2012-06-25
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