Deciphering India's Monetary Policy Transmission: A Structural VAR Perspective

Abstract

The question of how monetary measures disturbs the real variables in an economy is still an unsettled question for both researchers and policy makers. Central bank does frame the monetary measures to attain ultimate objective of the policy in terms of economic growth and stable inflation. This study has been taken out to analyse the efficacy and relative efficiency of various channels of monetary measures transmission in India along with their consolidated consequences on real activity in the post-reform period. By using monthly data from 1991M03 to 2019M03 (time series) and tried to examine the lag structure of monetary impulses on different real and financial variables by relying on structural vector auto-regression (SVAR) model. The findings suggest that tightening of monetary policy adversely affect the investment & lead to a decline in output growth of industry. The empirical results also reveal the positive response of inflation to interest rate, that is, a contraction in monetary policy turn in an increase in inflation, which holds up the existence of ‘price puzzle’ in the Indian economy. With regard to transmission channels the interest rate passage has found dominant in impacting production and prices, which is well supported by the credit channel. However, both the channels support the existence of strong ‘price puzzle’. There is evidence of an active exchange rate channel as well. Appreciation of the exchange rate driven by monetary policy lowers oil prices and lowers the cost of importing industrial inputs, which increases the growth of industrial output. Furthermore, a greater exchange rate raises the market's supply of currency, which eventually fuels inflation.