Monetary Policy Transmission in India: A Peep Inside the Black Box

Using SVAR models on quarterly data for 1996-97:1 to 2011-12:1, the paper examines the relative importance of various transmission channels of monetary policy to GDP growth and inflation in India. It finds that external exogenous factors prolong the impact of monetary policy transmission on GDP growth and inflation in India, while removing the problem of ‘price puzzle’. Among the various channels of transmission, interest rate channel, credit channel and asset prices channel are found to be important, while exchange rate channel is weak. A positive shock to policy rate leads to slowdown in credit growth with a lag of two quarters and subsequently impacts GDP growth and inflation negatively. The same monetary policy shock has a negative impact on asset prices from the third quarter onwards and, in turn, has a pronounced negative impact on GDP growth and inflation. Exchange rate channel is found to have an insignificant impact on GDP growth, but has non-negligible impact on inflation. Interest rate channel is found to account for about half of the total impact of monetary shocks on GDP growth and about one-third of the total impact on inflation, indicating that interest rate channel is the most important channel for monetary policy transmission in India.