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Inflation targeting and the changing transmission mechanism of monetary policy in India

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  • Alex, Dony

Abstract

We examine shifts in the conduct of monetary policy in India, before and after the adoption of inflation targeting (IT), while also accounting for the impact of COVID-19. Unlike existing studies that pre-date COVID-19, we employ a unified framework using a time-varying BVAR model with data spanning 1998 to 2024. We find that, prior to IT, contractionary monetary policy had a limited impact on inflation with presence of a price puzzle. In contrast, the IT period exhibits improved monetary policy transmission, with policy shocks exerting a stronger influence on inflation with the price puzzle disappearing, reflecting enhanced policy credibility. However, this effect weakens during the COVID-19 years. Interestingly, monetary policy had greater influence on the output gap and exchange rate in the pre-IT period, with diminished effects during IT and COVID-19 period. These findings underscore the effectiveness of inflation targeting in improving the transmission of monetary policy in India, though it shows limitations during COVID-19.

Suggested Citation

  • Alex, Dony, 2025. "Inflation targeting and the changing transmission mechanism of monetary policy in India," Economic Modelling, Elsevier, vol. 151(C).
    • Handle: RePEc:eee:ecmode:v:151:y:2025:i:c:s0264999325001361
    DOI: 10.1016/j.econmod.2025.107141
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