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Open Economies Review

, Volume 27, Issue 5, pp 871–893 | Cite as

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

  • William A. Barnett
  • Soumya Suvra Bhadury
  • Taniya Ghosh
Research Article

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.

Keywords

Monetary policy Monetary aggregates Divisia monetary aggregates Structural VAR Exchange rate overshooting Liquidity puzzle Price puzzle Exchange rate puzzle Forward discount bias puzzle 

JEL Classification

C32 E51 E52 F31 F41 

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Copyright information

© Springer Science+Business Media New York 2016

Authors and Affiliations

  • William A. Barnett
    • 1
    • 2
  • Soumya Suvra Bhadury
    • 1
  • Taniya Ghosh
    • 3
  1. 1.University of KansasLawrenceUSA
  2. 2.Center for Financial StabilityNew YorkUSA
  3. 3.Indira Gandhi Institute of Development Research (IGIDR)Reserve Bank of IndiaMumbaiIndia

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