Working of Expectations Channel of Monetary Policy Transmission in India

Author:

Goyal Ashima1,Parab Prashant1

Affiliation:

1. Indira Gandhi Institute of Development Research, Gen. A. K. Vaidya Marg, Santosh Nagar, Goregaon (E), Mumbai 400065, India

Abstract

In this paper, we examine the working of the expectations channel of monetary policy transmission for India, first by investigating the role of inflation expectations in an aggregate supply-demand (AS-AD) adapted to the Indian economy. Second, formulating an inflation function determining convergence of core inflation to its expected value in a fixed point arising through interactions between central bank (CB) expected inflation and expectations of different agents. Finally, we estimate SVARs with variables derived from the above exercises. We first estimate how expectations shocks affect macroeconomic aggregates. Second, we identify the shocks affecting expectations of households and professional forecasters (PFs). In addition, we estimate shocks influencing core inflation. Results suggest the expectation channel worked through interactions between PF forecasts and CB projections, with causality from CB projections to core and from core to household expectations. Supply shocks had short-run effects but core inflation dominated in the longer run. Expectations converged. The expectations channel of transmission to inflation was more effective through communication than through the policy rate, since the rate had low and sometimes even perverse effects. The relatively low impact of demand variables on inflation supports the hypothesized AS-AD structure.

Publisher

World Scientific Pub Co Pte Ltd

Subject

Economics and Econometrics,Finance,General Business, Management and Accounting

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