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Monetary operating procedures: Principles and the Indian process

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  • Ashima Goyal

    ()
    (Indira Gandhi Institute of Development Research)

Abstract

As markets deepen and interest elasticities increase it is optimal for emerging markets to shift towards an interest rate instrument since continuing monetization of the economy implies money demand shocks are large. In an extension of the classic instrument choice problem to the case of frequent supply shocks, it is shown the variance of output is lower with the interest rate rather than a monetary aggregate as instrument, if the interest elasticity of aggregate demand is negative, and the interest elasticity of money demand is high or low. It is necessary to design an appropriate monetary policy response to supply shocks. An evaluation of India's monetary policy procedures and of the recent fine-tuning of the liquidity adjustment facility finds them to be in tune with these first principles and in the direction of international best practices. But a survey of country experiences and procedures, and some aspects of the Indian context suggest further improvements.

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Paper provided by Indira Gandhi Institute of Development Research, Mumbai, India in its series Indira Gandhi Institute of Development Research, Mumbai Working Papers with number 2011-028.

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Length: 24 pages
Date of creation: Oct 2011
Date of revision:
Handle: RePEc:ind:igiwpp:2011-028

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Keywords: Monetary policy; operating procedures; instrument problem; LAF;

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  1. William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers 2, Board of Governors of the Federal Reserve System (U.S.).
  2. Alan S. Blinder & Michael Ehrmann & Marcel Fratzscher & Jakob De Haan & David-Jan Jansen, 2008. "Central Bank Communication and Monetary Policy: A Survey of Theory and Evidence," Journal of Economic Literature, American Economic Association, vol. 46(4), pages 910-45, December.
  3. Thomas Palley, 2007. "Asset-based Reserve Requirements: A Response," Review of Political Economy, Taylor & Francis Journals, vol. 19(4), pages 575-578.
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