Examining the differential impact of monetary policy in India: a policy simulation approach.
| Autor | Bhat, Sajad Ahmad |
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Introduction
A consensus about the "non-neutrality of money" has emerged from a spate of the empirical literature on monetary transmission. Although not permanent, monetary policy actions have a persistent effect on output and prices with some lags/delays (Friedman and Schwartz, 1963; Romar and Romar, 1989; Bernanke and Blinder, 1992; Christiano et al, 1994; Mohanty, 2012; Khundrakpum, 2012) [1]. However, how exactly the monetary policy exerts its influence on real output and prices through different but related channels of transmission is still a contentious issue and is usually referred to as "black box" (Bernanke and Gertler, 1995; Khundrakpum and Jain, 2012). Implying certainty of effect but the uncertainty of how it does is mainly due to the simultaneous operation of different channels and their dynamic behaviour over time (Mohanty, 2012).
Traditionally, four key channels of monetary transmission have been examined and assessed to ponder upon the mechanism of monetary transmission. These include traditional interest rate channel (Taylor, 1995), credit channel (Bernanke and Gertler, 1995), exchange rate channel (Obstfeld and Rogoff, 1995) and the asset price channel (Meltzer, 1995) [2]. Recently another channel, namely, expectation channel has also been introduced to explain the conduct of monetary policy through forward-looking behaviour (Yellen, 2011; Joyce et al, 2011). These various channels have been distinguished in the literature along the lines of neoclassical and non-neoclassical perspective [3]. The functions and interactions of these channels in a given economy are mostly conditioned upon operating procedures and framework of monetary policy, structure and depth of financial system along with the stage of development [4].
Effectiveness of monetary policy transmission in India has been analysed by several studies in the recent period (Nachane et al, 2002; Pandit et al, 2006; Singh and Kalirajan, 2007; Ghosh, 2009; Aleem, 2010; Patra and Kapur, 2012; Bhattacharya et al, 2011; Dhal, 2011; Mohanty, 2012; Khundrakpum, 2012, 2013; Khundrakpum and Jain, 2012; Kapur and Behera, 2012; Sengupta, 2014; Bhoi et al, 2016; Khundrakpum, 2017). These studies encompass a consensus on the real effects of monetary policy with some differences in persistence and lag of effect.
Most of the studies assessing the effectiveness of monetary policy in the existing paradigm, except a few such as (Nachane et al, 2002; Dhal, 2011; Sengupta, 2014; Khundrakpum, 2012, 2013, 2017) connote a uniform effect of monetary policy on the aggregate economy. However, given the heterogeneous nature of an economy, composed of diverse but interlinked sectors, the effect of the monetary policy stance might not be uniform (Nachane et al, 2002). Scarcely literature has now witnessed a shift from the existing paradigm of the uniform impact of monetary policy shocks to whether money matters differently to different but interlinked sectors or regions (Alam and Waheed, 2006; Sengupta, 2014).
This reflection of differential impact has immense significance for the macroeconomic stabilization as the central bank will have to weigh the varying repercussion of its actions on different sectors (Alam and Waheed, 2006). For instance, the decline in output after monetary tightening might be conceived as mild from an overall perspective, but it can be appreciable for some sectors. This differential influence will imply a policy design to care for distributional aspects that otherwise could be neglected/disregarded. Similarly, the output decline may be a result of either consumption postponement or a temporary slowdown in investment. However, the one emanating due to investment decline will have lasting growth implications compared to a decline in consumer demand. Also, the relative strength of expenditure changing or expenditure switching policies of trade balance stabilization may have varying consequences in the aftermath of monetary policy shock. Accordingly, information on the relative sensitiveness/insensitiveness of different sectors/components of aggregate demand towards monetary policy actions furnishes valuable insights to monetary authorities in framing appropriate policy.
It may be noted that the interest rate serves as the main instrument of monetary policy signaling in India under the liquidity adjustment facility, as the beginning of the 2000s with the abandonment of monetary targeting framework by 1998. However, given the cashintensive nature of the Indian economy, it may be argued that changes in the money supply, whether planned or unplanned, anticipated or unanticipated could have a significant impact on the real economy (Khundrakpum, 2013). In fact, the projection of monetary aggregates by Reserve bank of India (RBI) in its monetary policy review reflects its continued relevance in policy considerations. To fill the gap, the study attempts to answer the flowing questions. First, is the impact of monetary policy shocks as defined by changes in interest rate different from those defined by changes in pure money supply? Second do components of aggregate supply and aggregate demand respond differentially to these shocks?
The rest of the paper is organized as follows: Section 2 provides a brief overview of the existing literature. Section 3 outlines the structural specification of the model. Section 4 provides estimation, data and result in the discussion. Model evaluation and the results of policy simulations are discussed in Section 5. Finally, the paper concludes with a discussion of results and policy implications in Section 6.
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Literature review 2.1 General literature
The genesis of monetary transmission at a disaggregated level can be traced back to seminal works of Stiglitz and Weiss (1981) on asymmetric information, market imperfection and moral hazards, Bernanke and Gertler (1995) for balance sheet channel and Kashyap et al. (1992) and Kashyap and Stein (1995) for bank lending channel [5]. Afterwards on, scholars emphasized on product heterogeneity, capital and labour intensity of input mixture, the financial structure of firms, trade openness and price rigidities in products, and hence, contributed to evolving literature on disaggregated monetary transmission mechanism. Firstly, because of different financial or leverage structure of firms leading to varying external finance premium as postulated by credit channel of monetary transmission mechanism provides an explanation for the heterogeneous impact of monetary policy (Bernanke and Gertler, 1995). Thus, the smaller firms, which are usually dependent on domestic banks for their credit needs are more affected than larger firms, which have easier and greater access to non-bank and external sources of finance (Jansen et al., 2013). The studies conducted by Gertler and Gilchrist (1993), Kashyap et al. (1994); Domac (1999), Barth and Ramey (2000); Dedola and Lippi (2005) and Jansen et al. (2013) provided empirical support to the heterogeneous impact of monetary policy shocks in terms of product durability, firm size, financing requirement and borrowing capacity.
Secondly, the nature and leverage of products differ from sector to sector. Generally, investment and capital goods are associated with longer gestation periods, large investment requirements, are usually highly valued and financed through credit, unlike consumer goods. Thus, changing interest rates will lead to more alterations in the real cost of these goods than consumer goods and along with their demand (Sengupta, 2014; Peersman and Smets, 2002; Angeloni et al., 2003; and Jakab et al., 2006). The studies offered an explanation of the differential monetary policy impacts. Thirdly, variation in capital-labor intensity among different production sectors provides yet another possible explanation for the heterogeneity effects (Berument et al., 2007; Hayo and Uhlenbrock, 1999; Ganley and Salmon, 1997). The studies reported the substantial response of capital-intensive than laborintensive industries, heavy industries than non-durable and manufacturing, construction and transportation than sectors such as financial services and utilities to a monetary policy shock.
Fourthly, product characteristics such as being durable and non-durable provide another important illustration (Mishkin, 1976; Haimowitz, 1996; Kretzmer, 1989; Dedola and Lippi, 2005; Peersman and Smets, 2002; Erceg and Levin, 2002) to the differential impact of monetary policy shocks. Fifthly, a combination of tradable and non-tradable goods and domestic and imported raw material varies across firms. Thus, the sensitiveness of different sectors to exchange rate channels of monetary transmission plays an important role in explaining the heterogeneous effects (Llaudes, 2007).
2.2 Studies specifically for India
A few studies have analysed the disaggregated monetary transmission mechanism in the case of India as well. Nachane et al. (2002), Ghosh (2009); Dhal (2011), Khundrakpum (2012); Sengupta (2014) and Khundrakpum (2013) examined the differential effects of policy rate and money supply shocks in India using the data for different periods and of different frequencies. The studies supported the real effects of both the shocks along with differential impact among the components of aggregate demand.
After reviewing the available studies in general and those focussing on India in particular, a common thread running through all is the heterogeneous response to monetary policy shocks emanating from components of aggregate demand and aggregate supply. However, it can be observed from above that this issue has not been studied rigorously in the context of India, especially with due consideration to all intersectoral linkages in the overall macro-econometric framework. Hence, the study is an attempt to fill this gap at an empirical level.
2.3 Specification, estimation and data of the model
The model presented here is theoretically eclectic and primarily belongs...
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