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Inflation targeting in India: A comparison with the multiple indicator approach

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  • Mishra, Ankita
  • Mishra, Vinod

Abstract

The empirical literature on identification and measurement of the impact of monetary policy shocks on the real side of the economy is fairly comprehensive for developed economies, but very limited for emerging and transition economies. In this study, we propose an identification scheme for a developing economy (taking India as a case study), which is able to capture the monetary transmission mechanism for that economy without giving rise to empirical anomalies. Using a VAR approach with recursive contemporaneous restrictions, we identify monetary policy shocks by modelling the reaction function of the central bank and structure of that economy. The effect of monetary policy shocks on the exchange rate and other macroeconomic variables is consistent with the predictions of a broad set of theoretical models. This set-up is used to build a hypothetical case of inflation targeting where the monetary policy instrument is set after assessing the current values of inflation only. This is in contrast with the ‘multiple indicator approach’ currently followed by the Reserve Bank of India (RBI). The results in this study suggest that the demand effects of interest rate are stronger than the exchange rate effects. There is also evidence of the mitigation of potential conflict between exchange rate and interest rate, one of main monetary policy dilemmas of the RBI in inflation targeting.

Suggested Citation

  • Mishra, Ankita & Mishra, Vinod, 2012. "Inflation targeting in India: A comparison with the multiple indicator approach," Journal of Asian Economics, Elsevier, vol. 23(1), pages 86-98.
    • Handle: RePEc:eee:asieco:v:23:y:2012:i:1:p:86-98
    DOI: 10.1016/j.asieco.2011.10.003
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    Cited by:

    1. Mandel, Antoine & Veetil, Vipin P., 2021. "Monetary dynamics in a network economy," Journal of Economic Dynamics and Control, Elsevier, vol. 125(C).
    2. Goyal, Ashima & Agarwal, Deepak Kumar, 2020. "Policy transmission in Indian money markets: The role of liquidity," The Journal of Economic Asymmetries, Elsevier, vol. 21(C).
    3. Rasool, Haroon & Adil, Masudul Hasan & Tarique, Md, 2018. "An Empirical Evidence of Dynamic Interaction among price level, interest rate, money supply and real income: The case of the Indian Economy," MPRA Paper 87452, University Library of Munich, Germany.
    4. Roy, Rudra Prosad & Sinha Roy, Saikat, 2022. "Commodity futures prices pass-through and monetary policy in India: Does asymmetry matter?," The Journal of Economic Asymmetries, Elsevier, vol. 25(C).
    5. Rakshit, Bijoy & Bardhan, Samaresh, 2023. "Does bank competition affect the transmission mechanism of monetary policy through bank lending channel? Evidence from India," Journal of Asian Economics, Elsevier, vol. 86(C).
    6. Junankar, Pramod N. (Raja), 2019. "Monetary Policy, Growth and Employment in Developing Areas: A Review of the Literature," IZA Discussion Papers 12197, Institute of Labor Economics (IZA).

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    More about this item

    Keywords

    India; Inflation targeting; Monetary policy; VAR;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications

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