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An SVAR Approach to Evaluation of Monetary Policy in India: Solution to the Exchange Rate Puzzles in an Open Economy

Author

Listed:
  • William A. Barnett

    (University of Kansas
    Center for Financial Stability)

  • Soumya Suvra Bhadury

    (University of Kansas)

  • Taniya Ghosh

    (Reserve Bank of India)

Abstract

Following the exchange-rate paper by Kim and Roubini (J Monet Econ 45(3):561–586, 2000), we revisit the questions on monetary policy, exchange rate delayed overshooting, the inflationary puzzle, and the weak monetary transmission mechanism; but we do so for the open Indian economy. We further incorporate a superior monetary measure, the aggregation-theoretic Divisia monetary aggregate. Our paper confirms the efficacy of the Kim and Roubini (J Monet Econ 45(3):561–586, 2000) contemporaneous restriction, customized for the Indian economy, especially when compared with recursive structure, which is damaged by the price puzzle and the exchange rate puzzle. The importance of incorporating correctly measured money into the exchange rate model is illustrated, when we compare models with no-money, simple-sum monetary measures, and Divisia monetary measures. Our results are confirmed in terms of impulse response, variance decomposition analysis, and out-of-sample forecasting. In addition, we do a flip-flop variance decomposition analysis, finding two important phenomena in the Indian economy: (i) the existence of a weak link between the nominal-policy variable and real-economic activity, and (ii) the use of inflation-targeting as a primary goal of the Indian monetary authority. These two main results are robust, holding across different time period, dissimilar monetary aggregates, and diverse exogenous model designs.

Suggested Citation

  • William A. Barnett & Soumya Suvra Bhadury & Taniya Ghosh, 2016. "An SVAR Approach to Evaluation of Monetary Policy in India: Solution to the Exchange Rate Puzzles in an Open Economy," Open Economies Review, Springer, vol. 27(5), pages 871-893, November.
    • Handle: RePEc:kap:openec:v:27:y:2016:i:5:d:10.1007_s11079-016-9403-2
    DOI: 10.1007/s11079-016-9403-2
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    3. Georgiadis, Georgios & Jančoková, Martina, 2020. "Financial globalisation, monetary policy spillovers and macro-modelling: Tales from 1001 shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 121(C).
    4. Lateef Olawale Akanni, 2020. "Climatic Variations and Spatial Price Differentials of Perishable Foods in Nigeria," Econometric Research in Finance, SGH Warsaw School of Economics, Collegium of Economic Analysis, vol. 5(1), pages 1-15, June.
    5. Ghosh, Taniya & Bhadury, Soumya Suvra, 2017. "Exchange Rate Overshooting: A Reassessment in a Monetary Framework," MPRA Paper 90653, University Library of Munich, Germany.
    6. Umit Bulut, 2023. "Measuring the impacts of monetary policy in Turkey: an extended structural vector autoregressive model with structural breaks," International Journal of Economic Policy Studies, Springer, vol. 17(1), pages 117-132, February.
    7. Jugnu Ansari & Saibal Ghosh, 2021. "Monetary Policy Pass-through, Ownership and Crisis: How Robust is the Indian Evidence?," Margin: The Journal of Applied Economic Research, National Council of Applied Economic Research, vol. 15(4), pages 456-483, November.
    8. Grebenkina, A. & Khandruev, A., 2021. "Difference in intensity of exchange rate factors in countries with targeting inflation regime," Journal of the New Economic Association, New Economic Association, vol. 51(3), pages 125-143.
    9. Ganbold, Batzorig & Akram, Iqra & Fahrozi Lubis, Raisal, 2017. "Exchange rate volatility: A forecasting approach of using the ARCH family along with ARIMA SARIMA and semi-structural-SVAR in Turkey," MPRA Paper 84447, University Library of Munich, Germany, revised 2017.

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    More about this item

    Keywords

    Monetary policy; Monetary aggregates; Divisia monetary aggregates; Structural VAR; Exchange rate overshooting; Liquidity puzzle; Price puzzle; Exchange rate puzzle; Forward discount bias puzzle;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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