Financial frictions, bank intermediation and monetary policy transmission in India

Abstract

Do the different types of financial friction have differential implications for monetary transmission in emerging economies? We investigate this question using India as the country for analysis. We adopt a New Keynesian business cycle model with bank intermediation, extend it by the Indian economy-specific features and validate with the data. The baseline model explains the co-movements of interest rates, incomplete pass-through and sluggish adjustment mechanism of the macro-financial variables for a policy interest rate shock. It identifies the collateral-constrained, financially excluded households and low proportion of savers as the primary sources of frictions causing weak monetary transmission.

Efficacy of Monetary Policy Transmission During the Flexible Inflation Targeting Regime in India

“…Most studies have found plausible effects 8 of monetary policy shocks during the MI targeting regime in India (Al Mashat, 2003;Aleem, 2010;Bhoi et al, 2017;Khundrakpam & Jain, 2012). On the contrary, there are others who have found no effect of monetary policy shocks on inflation and output during the same period (Banerjee et al, 2018;Bhattacharya et al, 2010;Mishra et al, 2016). Studies examining this effect have mainly relied on VAR frameworks (Aleem, 2010;Bhoi et al, 2017;Sengupta, 2014) that use Cholesky decomposition techniques (e.g., Eichenbaum & Evans, 1995;Grilli & Roubini, 1995;Sims, 1992) under which the monetary policy does not react to instantaneous changes in the exchange rate.…”