Monetary Policy and Food Prices in India

Using a vector error correction model (VECM), the paper examines the relative response of food and manufactured prices to change in interest rate and money supply in India during the period 2001:Q1 to 2010:Q2. It finds that, in the long-run, while money supply leads to rise in the prices of both food and manufactured prices, hike in call rate has a negative effect only on manufactured prices. The impact of money supply is, however, more on food prices than on manufactured prices. There is no evidence of long-run neutrality of money, as increase in money supply leads to less than proportionate change in price. In the short-run, there is overshooting in the prices of both food and manufactured products from their respective long-run equilibrium following monetary shocks. The overshooting, however, is more in food prices than in manufactured prices. Further, in the shortrun, call rate has a significant impact only on manufactured prices, while the impact of money supply is significant only on food prices. Both food and manufactured prices increase induces call rate hike. But money supply increases with rise in food prices and decreases with the rise in manufactured prices.