The IUP Journal of Applied Economics
Monetary Policy Transmission in India: Interest Rate Puzzle

Article Details
Pub. Date : Jul, 2019
Product Name : The IUP Journal of Applied Economics
Product Type : Article
Product Code : IJAE21907
Author Name : Kajleen Kaur and Ananya Ghosh Dastidar
Availability : YES
Subject/Domain : Economics
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No. of Pages : 22

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Abstract

The interest rate transmission mechanism of monetary policy to real economic activity has been the center of interest of many researchers globally. The aim of this paper is to study the impact of the policy interest rate (both nominal and real interest rates) on the output gap in India for the period from May 2001 to March 2015 using monthly data, and explore whether the Reserve Bank’s switching to inflation targeting has hampered the growth objective. The paper uses Autoregressive Distributed Lag (ARDL) cointegration approach to study the long-run and shortrun dynamics of the objective variables. It takes sufficient number of lags to handle the problem of endogeneity mostly present amongst macroeconomic variables. The study finds presence of interest rate puzzle, where the conventional negative relationship between output and interest rate is broken. It suggests the presence of some other factors such as business mood, investment uncertainty, presence of parallel economy or the time period which was dominated by global financial crisis and its aftermath as the possible reasons for the decline in growth rate.


Description

Monetary policy is often used for macroeconomic stabilization. There are various monetary policy tools which are used for achieving the same, but in the recent past, interest rate has been dominantly and frequently used. The use of interest rate as a policy tool however has been considered as a blunt tool, where monetary authority has to compromise either on the growth or stable inflation objective. The recent shift of Reserve Bank of India (RBI) to inflation targeting post global financial crisis, is sometimes considered as anti-growth, where high interest pattern to control inflation leads to low economic growth. The paper thus does an extensive study of the interest rate pattern and its impact on output level of the economy.

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