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Liquidity management and monetary transmission: Empirical analysis for India

Author

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  • Vikas Chamal

    (Indira Gandhi Institute of Development Research)

  • Ashima Goyal

    (Indira Gandhi Institute of Development Research)

Abstract

A change in monetary operating procedures provides a natural experiment we use to evaluate first whether Indian monetary policy transmission is better when durable liquidity is in surplus or when it is in deficit; second is it better with interest rates as the policy instrument or quantity of money or a mixture of the two. After showing our period of analysis can be divided into two liquidity regimes, we estimate separate structural vector auto-regressions for the financial and real sector, as well as SVARs for the whole period with alternative operating instruments. Monetary transmission from the repo rate was better during the period the liquidity adjustment facility (LAF) was in surplus with the central bank in absorption mode denoting excess durable liquidity. Pass through was faster and the repo rate had a greater influence on other variables. The impact of the rate on output gap exceeds that on inflation. The weighted average call money rate was found to outperform others as the operating target. Monetary policy has evolved so that policy rates are more effective in transmission compared to money supply, but best results are when durable liquidity is also in surplus. The results suggest keeping the LAF in deficit mode over 2011-19 was not optimal.

Suggested Citation

  • Vikas Chamal & Ashima Goyal, 2021. "Liquidity management and monetary transmission: Empirical analysis for India," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2021-008, Indira Gandhi Institute of Development Research, Mumbai, India.
    • Handle: RePEc:ind:igiwpp:2021-008
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    References listed on IDEAS

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    1. 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).
    2. Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148, Elsevier.
    3. Khundrakpam, Jeevan Kumar & Jain, Rajeev, 2012. "Monetary Policy Transmission in India: A Peep Inside the Black Box," MPRA Paper 50903, University Library of Munich, Germany.
    4. Chetan Ghate & Kenneth M. Kletzer (ed.), 2016. "Monetary Policy in India," Springer Books, Springer, number 978-81-322-2840-0, January.
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    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
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes

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