tailieunhanh - Evidence on Interest Rate Channel of Monetary Policy Transmission in India

Keynes’s liquidity preference theory touched on the maturity transformation issue. He argued that the private sector’s willingness to assume liquidity and maturity risks is not well-anchored in fundamentals. Instead it is strongly influenced by subjective factors. Hence his policy prescription was that government debt issuance should “accommodate the preferences of the public for different maturities”. It was, he argued, socially desirable that risk-averse investors should be offered some minimum, safe return on their capital. The real long-term rate of interest should not go to zero. Equally, it should not be too high. Keynes’s view was that, in periods of extreme. | Evidence on Interest Rate Channel of Monetary Policy Transmission in India By Deepak Mohanty Executive Director Reserve Bank of India With the development of domestic financial markets and gradual deregulation of interest rates monetary policy operating procedure in India in the recent years has evolved towards greater reliance on interest rates to signal the stance of monetary policy. This process is buttressed by significant evidence that policy rate changes transmit through the term structure of interest rates though the intensity of transmission varies across financial markets. But how does policy rate change affect output and inflation remains an open question Following a quarterly structural vector autoregression SVAR model we find evidence that policy rate increases have a negative effect on output growth with a lag of two quarters and a moderating impact on inflation with a lag of three quarters. The overall impact persists through 8-10 quarters. These results are found to be robust across alternative specifications with different measures of output inflation and liquidity. Moreover significant unidirectional causality was found from policy interest rate to output inflation and various measures of liquidity except broad money M3 underlining the importance of interest rate as a potent monetary policy tool. JEL Classification E43 E52 E58 Key words Interest Rate Channel Monetary Policy Monetary Transmission Structural VAR 1. Introduction How does monetary policy affect output and inflation is an important question The monetary policy framework of a central bank aims to attain the desired objectives of policy in terms of inflation and growth. Typically central banks exercise control over the monetary base and or short term interest rates such as the rate at which the central bank supplies or absorbs reserves to from the banking system in the economy. How these interest rate actions and liquidity operations of the central banks impact the end-objectives depends

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