Monetary policy during Negative Output Gap periods in India in the First Quarter of the 21st Century

This article reviews the conduct of monetary policy in India during periods of slow growth in the first quarter of the 21st century. Using standard univariate filtering techniques, the article first identifies periods of slow growth, i.e., periods of negative output gap. It then uses the inflation rate and other supporting indicators to determine whether these periods were demand or supply constrained. The article then reviews the conduct of monetary policy during each of these episodes. An important takeaway is that monetary policy in the Indian context is very complex. Taylor type rules or even rules linking monetary policy stance to binding demand or supply constraints are by themselves inadequate for the conduct of monetary policy. They need to be combined with discretion and judgements based on comprehensive, detailed assessments of economic conditions. The article also reviews time lags and effectiveness in the transmission of monetary policy during both the Multiple Indicator Regime and the Inflation Targeting regime, particularly with reference to the interest rate channel. We find that transmission occurs with a time lag of 2-3 quarters, however it remains incomplete.