Monetary policy analysis in an inflation targeting framework in emerging economies: The case of India

NIPFP Working Paper 131
[Link]

Rudrani Bhattacharya and Ila Patnaik
February 2014

Abstract

Monetary policy in India has moved towards an increasingly flexible exchange rate regime without any explicit framework for an alternative nominal anchor. The failure of monetary policy to anchor inflationary expectations of agents, coupled with negative supply shocks has kept inflation above the acceptable range of 5-5.5% for last five years in India. In this paper we present a model for policy analysis for India that provides insights in the setting of an inflation targeting framework to anchor inflationary expectations. The model offers an understanding of the extent to which various shocks, including the post-global crisis fiscal stimulus, accommodative monetary policy and ensuing decline in global demand, explain growth and inflation in India.

Monetary and Fiscal Policy in a DSGE Model of India

NIPFP Working Paper 96
[PDF]

Paul Levine and Joseph Pearlman
November 2011

Abstract

We develop a optimal rules-based interpretation of the ‘three pillars macroeconomic policy framework’: a combination of a freely floating exchange rate, an explicit target for inflation, and a mechanism than ensures a stable government debt-GDP ratio around a specified long run. We show how such monetary-fiscal rules need to be adjusted to accommodate specific features of emerging market economies. The model takes the form of two-blocs, a DSGE emerging small open economy interacting with the rest of the world and features, in particular, financial frictions. It is calibrated using India and US data. Alongside the optimal Ramsey policy benchmark, we model the three pillars as simple monetary and fiscal rules including and both domestic and CPI inflation targeting interest rate rules. A comparison with a fixed exchange rate regime is made. We find that domestic inflation targeting is superior to partially or implicitly (through a CPI inflation target) or fully attempting to stabilizing the exchange rate. Financial frictions require fiscal policy to play a bigger role and lead to an increase in the costs associated with simple rules as opposed to the fully optimal policy. These policy prescriptions contrast with the monetary-fiscal policy stance of the Indian authorities.

Did the Indian Capital Controls Work as a Tool of Macroeconomic Policy?

NIPFP Working Paper 87
[Link]

Ila Patnaik and Ajay Shah
April 2011

Abstract

In 2010 and 2011, there has been a fresh wave of interest in capital controls. India is one of the few large countries with a complex system of capital controls, and hence offers an opportunity to assess the extent to which these help achieve goals of macroeconomic and financial policy. We find that the capital controls were associated with poor governance, were unable to sustain the erstwhile exchange rate regime, and did not support financial stability. India's experience is thus inconsistent with the revisionist view of capital controls. Macroeconomic policy in India has moved away from the erstwhile strategies, towards greater exchange rate flexibility combined with capital account liberalisation.

Early warnings of inflation in India

NIPFP Working Paper 54,

Rudrani Bhattacharya, Ila Patnaik and Ajay Shah
August, 2008

Abstract
In India, year-on-year percentage changes of price indexes are widely used as the measure of inflation. In terms of monthly data, each observation of a one-year change in inflation is the sum of twelve one-month changes. This suggests that better information about inflationary pressures can be obtained using point-on-point monthly changes. This requires seasonal adjustment. We apply standard seasonal adjustment procedures in order to obtain a point-on-point seasonally adjusted monthly time-series of inflation in India. In three interesting high inflation episodes – 1994-95, 2007 and 2008 - we find that this data yields a faster and better understanding of inflationary pressures.

This paper also appeared as Planning Commission Working Paper No. 1/2008- PC

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Fiscal Policy and Economic Reforms

NIPFP Working Paper 53,

Y.V.Reddy
July, 2008

In an lecture at NIPFP, RBI Governor Dr. Y.V Reddy gives a practitioner's perspective of fiscal policy and economic reforms.


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Managing Capital Flows: The case of India

NIPFP Working Paper 52,

Ajay Shah and Ila Patnaik
May, 2008

Abstract
From the early 1990s, India embarked on easing capital controls. Liberalization emphasised openness towards equity flows, both FDI and portfolio flows. In particular, there are few barriers in the face of portfolio equity flows. In recent years, a massive increase in the value of foreign ownership of Indian equities has come about, largely reflecting improvements in the size, liquidity and corporate governance of Indian firms. While the system of capital controls appears formidable, the de facto openness on the ground is greater than is apparent, particularly because of the substantial enlargement of the current account. These changes to capital account openness were not accompanied by commensurate monetary policy reform. The monetary policy regime has consisted essentially of a pegged exchange rate to the US dollar throughout. Increasing openness on the capital account, coupled with exchange rate pegging, has led to a substantial loss of monetary policy autonomy. The logical way forward now consists of bringing the de jure capital controls uptodate with the defacto convertibility, and embarking on reforms of the monetary policy framework so as to shift the focus of monetary policy away from the exchange rate to domestic inflation.

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New Issues in Indian Macro Policy

NIPFP Working Paper 51,

Ajay Shah
May, 2008

Abstract
Macroeconomic policy thinking in India has been rooted in an environment with five key parameters: agricultural shocks rather than a conventional business cycle, a closed economy, deeply distortionary tax policy coupled with a fiscal crisis, financial markets that lacked speculative price discovery, and a monetary policy shaped by deficit financing. This environment has been completely altered through India’s integration into the world economy, the rise of one financial market (the equity market), the reduced importance of the monsoon, the rise of conventional business cycle dynamics, a partial abatement of the fiscal crisis and a monetary policy environment with loss of autonomy owing to exchange rate pegging. These changes call for a rethink of the macroeconomic policy framework. The agenda of assuring fiscal stability needs to be seen to its conclusion. Monetary policy and fiscal policy need to be converted into tools for macroeconomic stabilisation.

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