Indian Journal of Economics and Development

Open Access Open Access  Restricted Access Subscription Access

Monetary Policy in India During Crisis:Impact on Inflation


Affiliations
1 SGGSCC, University of Delhi, India
2 Deen Dayal Upadhyaya College, University of Delhi, India
 

Objectives: The study aims to compare the effectiveness of monetary policy in controlling inflation in India during pre and post global financial crisis by analysing the long term and short-term relationship between inflation gap, output gap, fiscal deficit, nominal exchange rate, money supply and interest rate. Methods/Statistical analysis: The study employs Auto Regressive Distributed Lag (ARDL) to co-integration. It is an advanced technique since it allows the flexibility to use variables of different order of integration (I(0) and I(1)) as compared to other methods such as VAR or VECM, which work on differenced variables and therefore led to loss of data. It also takes sufficient number of lags to avoid the problem of endogeneity in the models.Findings: The ARDL co-integration results suggest that interest rate isan effective tool of monetary policy in controlling inflation in India. The effectiveness however does reduce in the post-crisis period. It implies fiscal dominance of the monetary policy, where fiscal deficit per se does not cause inflation; still it can impact the latter through its transmission to the monetary policy, as was the case in the post global financial crisis period. The co-integration results also suggest that output gap, foreign exchange rate and money supply all have a significant impact on inflation gap, with no change in the behaviour of former two on inflation gap in the pre-and post-crisis period. While the money supply variable becomes less effective in the latter period. Crude oil price is found to be insignificant during the pre-crisis period but becomes significant during post crisis, while fiscal deficit remains insignificant in both the periods. Application/Improvements: This study supports the use of interest rate as a monetary policy tool, which is extremely relevant in wake of the shift of Indian monetary policy to inflation targeting. It highlights the need to control fiscal deficit for controlling inflation.

Keywords

Monetary Policy, Inflation Gap, Interest Rate, Financial Crisis, ARDL.
User
Notifications

  • S. Acharya. Macroeconomic performance and policies, 2000-2008. In: Shankar Acharya and Rakesh Mohan (ed.), India’s economy, performance and challenges: Essays in Honour of Montek Singh Ahluwalia. 2010; 3, 39-81.

  • K. Basu. Understanding inflation and controlling it. Economic and Political Weekly. 2011; 46(41), 50-64.

  • M. Friedman. The role of monetary policy. American Economic Review. 1968; 58(1), 1-17.

  • J.M. Keynes. The general theory of employment, interest and money. Macmillian, London. 1936.

  • T.J. Sargent, N. Wallace. Some unpleasant monetarist arithmetic. Quarterly Review Federal Reserve Bank of Minneapolis. 1981.

  • P. Balakrishna. Pricing and inflation in India. New Delhi: Oxford University Press. 1991.

  • C. Kindleberger, R. Aliber. Manias, panics and crashes: A history of financial crises. Fifth Edition. New Jersey: Wiley. 2005.

  • Reserve Bank of India (2012) Fiscal-Monetary co-ordination in India: An assessment. Report on Currency and Finance. Mumbai.

  • D. Mohanty. Unconventional monetary policy – the Indian experience with crisis response and policy exit. RBI Speeches. 2013; 1-5.

  • S. Yanamandra. Minsky, monetary policy and Mint Street: Challenges for the art of monetary policymaking in emerging economies. Manchester Business School WP/820. 2014; 1-44.

  • A. Darrat. Inflation in Saudi Arabia: An econometric investigation. Journal of Economic Studies. 1985; 12(4), 44-51.

  • C.H. Lim, L. Papi. An econometric analysis of determinants of inflation in Turkey. IMF Working Paper 97/170. 1997; 1-33.

  • K. Metin. An integrated analysis of Turkish inflation. Oxford Bulletin of Economics and Statistics. 1995; 57(4), 412-422.

  • L. Bonato. Money and inflation in the Islamic Republic of Iran. IMF Working Paper 07/119, Washington, DC: International Monetary Fund. 2007.

  • M. Kandil, H. Morsy. Determinants of inflation ion GCC. Middle East Development Journal (MEDJ) World Scientific Publishing Co. Pvt. Ltd. 2011; 3(2), 141-158.

  • N. Asad, Z. Hussain. Impact of real effective exchange rate on inflation in Pakistan. Asian Economic and Financial Review. 2013; 2(8), 983–990.

  • J.H. Cochrane. Do higher interest rates raise or lower inflation? Becker Friedman Institute. 2016.

  • D. Romer. Openness and inflation: Theory and evidence. The Quarterly Journal of Economics. 1993; 108(4), 869-903.

  • S. Ashra. Inflation and openness: a study of selected developing economies. Indian Council for Research on International Economic Relations, WP/84. New Delhi. 2002; 1-36.

  • T.N. Dhar. The price perspective. Yojana. 1972; 16(18), 755-758.

  • K. Guha. Inflation and growth. Yojana. 2005; 49, 75-76.

  • R.N. Gupta. Can the trend be reversed? Yojana. 1972; 16(18), 759-761.

  • J.K. Khundrakpam, S. Pattanaik. Global crisis, fiscal response and medium-term risks to inflation in India. Reserve Bank of India Occasional Papers. 2010; 31(2), 1-29.

  • Reserve Bank of India. Report on Currency & Finance. 2003-04. 2005.

  • M. Dash. Impact of macroeconomic factors on inflation: An assessment on Indian economy by using vector auto-regressive modelling. Journal of Decision Sciences Applications. 2016; 1(1), 21-28.

  • C. Rangarajan, R.R. Arif. Money output and prices – A macro econometric model. Economic and Political Weekly. 1990; 25(16), 837-852.

  • M.D. Patra, P. Ray. Inflationary expectations and monetary policy in India: An empirical exploration. IMF Working Paper. WP/10/84. 2010; 1-27.

  • C. Rangarajan. We broke the ban: A decade ago. Economic Times. 2006.

  • M. Pahlavani, M. Rahimi. Sources of inflation in Iran: An application of the ARDL approach. International Journal of Applied Economics and Quantitative Studies. 2009; 6(1); 61-76.

  • A.V. Rajwade. Inflation and monetary policy. Board of Governors of the Federal Reserve System, Yojana. 2007; 51, 17-19.

  • S. Aiyar, S. Anklesaria. India disproves Friedman on inflation. Economic Times. 2008; 16.

  • R.C. Ummat. An agenda for containing inflation. Kurukshetra. 1992; 40(7), 9-10.

  • S. Shankar. Bringing inflation under control. Yojana. 1992; 36(8), 27-28.

  • M.K. Ghoshal. Inflation: Review and outlook. Yojana. 1993; 36(24), 4-5.

  • P. Arunachalam, K.C. Sankaranarayanan. Liberalization and inflation in India. Yojana, 1998; 42(11), 7-9.

  • Q. Alam, S. Alam. The determinants of inflation in India: The bounds test analysis. International Journal of Economics and Financial Issues. 2016; 6(2), 544-550.

  • When and why does Bangladesh’s Inflation differ from Indian’s? http://www.bb.org.bd/pub/research/workingpaper/wp1301.pdf. Date accessed: 14/01/2013.

  • B.B. Bhattacharya, M. Lodh. Inflation in India: An analytical survey. Artha Vijnana 1990; 32(1), 25-63.

  • P. Brahmananda, G. Najraj. Inflation and growth in the world: Some simple empirics, 1970-99. In: Macroeconomics and Monetary Policy: Issues for a Reforming Economy New Delhi: Oxford University Press. 2002; 43-66.

  • S. Das. Modeling money, price and output in India: A vector autoregressive and moving average approach. Applied Economics. 2003; 35, 1219-1225.

  • P. Balakrishnan. Growth and inflation. Yojana. 2007; 51, 8-10.

  • R.H. Dholakia. Extended Phillips curve for the Indian economy. Indian Economic Journal. 1990; 38(1), 69-78.

  • M. Ramachandran. Do broad money, output and prices count in India? Journal of Policy Modelling. 2004; 26, 982-1001.

  • B.K. Kaushik. Understanding inflation and controlling it. Economic and Political Weekly. 2011; 46(41), 50-64.

  • B.P. Paul. In search of the Phillips curve for India. Journal of Asian Economics. 2009; 20(4), 479-488.

  • Goyal. Understanding high inflation trend in India. South Asian Journal of Macroeconomics and Public Finance. 2014; 4(1), 1–44.

  • L. Chakraborty, K.O. Varma. Efficacy of new monetary framework and determining inflation in India: An empirical analysis of financially deregulated regime. Working Papers No. 153. National Institute of Public Finance and Policy. 2015; 1-19.

  • A. Patnaik. Study of inflation in India: A co-integrated VAR approach. Journal of Quantitative Economics. 2010; 8(1); 118-129.

  • N. Srinivasan, V. Mahambare, M. Ramachandran. Modelling inflation in India: A critique of the structural approach. Journal of Quantitative Economics. 2006; 4(2), 45-59.

  • V.K. Joshi. Impact of monetary policy of India with special reference to CRR, repo and reverse Repo in curbing inflation and econometric study. Management Insight. 2013; 8(2).

  • The Effect of crude oil prices on inflation and interest rates in India: Evidence from DCC-GARCH Model. https://ssrn.com/abstract=2472558. Date accessed: 28/07/2014.

  • W.H. Branson. Macroeconomic theory and policy. Business and Economics. Harper Collin Publisher. 1979; 1-656.

  • Reserve Bank of India. Report of the expert committee to revise and strengthen the monetary policy framework (Patel Committee Report). 2014.

  • R.E. Lucas. Some international evidence on output-inflation trade-offs. American Economic Review. 1973; 63, 326-34.

  • M.H. Pesaran, Y. Shin, R.J. Smith. Bounds testing approaches to the analysis of level relationships. Journal of Applied Econometrics. 2001; 16, 289-326.

  • H.M. Pesaran, B. Pesaran. Micro fit 4.0. Oxford University Press. 1997.

  • J. Laurenceson J. Chai. Financial reform and economic development in China. Cheltenham, UK, Edward Elgar. 2003.

  • D. Mohanty. Inflation dynamics in India: Issues and concerns. Speech delivered at Bombay Chamber of Commerce & Industry, published in RBI Monthly Bulletin, RBI, Bombay. 2010; 763-769.

  • V. Dhar. Caught between a rock and hard place. Financial Times (March 23) Economic Survey 2011-12. 2014.


Abstract Views: 266

PDF Views: 137




  • Monetary Policy in India During Crisis:Impact on Inflation

Abstract Views: 266  |  PDF Views: 137

Authors

Kajleen Kaur
SGGSCC, University of Delhi, India
Yogieta S. Mehra
Deen Dayal Upadhyaya College, University of Delhi, India

Abstract


Objectives: The study aims to compare the effectiveness of monetary policy in controlling inflation in India during pre and post global financial crisis by analysing the long term and short-term relationship between inflation gap, output gap, fiscal deficit, nominal exchange rate, money supply and interest rate. Methods/Statistical analysis: The study employs Auto Regressive Distributed Lag (ARDL) to co-integration. It is an advanced technique since it allows the flexibility to use variables of different order of integration (I(0) and I(1)) as compared to other methods such as VAR or VECM, which work on differenced variables and therefore led to loss of data. It also takes sufficient number of lags to avoid the problem of endogeneity in the models.Findings: The ARDL co-integration results suggest that interest rate isan effective tool of monetary policy in controlling inflation in India. The effectiveness however does reduce in the post-crisis period. It implies fiscal dominance of the monetary policy, where fiscal deficit per se does not cause inflation; still it can impact the latter through its transmission to the monetary policy, as was the case in the post global financial crisis period. The co-integration results also suggest that output gap, foreign exchange rate and money supply all have a significant impact on inflation gap, with no change in the behaviour of former two on inflation gap in the pre-and post-crisis period. While the money supply variable becomes less effective in the latter period. Crude oil price is found to be insignificant during the pre-crisis period but becomes significant during post crisis, while fiscal deficit remains insignificant in both the periods. Application/Improvements: This study supports the use of interest rate as a monetary policy tool, which is extremely relevant in wake of the shift of Indian monetary policy to inflation targeting. It highlights the need to control fiscal deficit for controlling inflation.

Keywords


Monetary Policy, Inflation Gap, Interest Rate, Financial Crisis, ARDL.

References