DOCSLIB.ORG

Agrarian Performance & Food Price Inflation in India

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Agrarian Performance & Food Price Inflation in India Agrarian Performance & Food Price Inflation in India: Pre- and Post-Economic Liberalisation Article by: Sthanu R Nair & Leena Mary Eapen Course : Indian Economy 2 B.A. Hons Economics, Semester VI Delhi University Course Instructor: Siddharth Rathore Assistant Professor Economics Department, Gargi College Siddharth Rathore SPECIAL ARTICLE Agrarian Performance and Food Price Inflation in India Pre- and Post-Economic Liberalisation Sthanu R Nair, Leena Mary Eapen Examining long-term trends in food inflation in India in 1 Introduction relation to the performance of the Indian agricultural he post-economic reforms (post-ER) period1 in India has been characterised by a slowdown in the growth rate of sector under various agrarian policy regimes, this paper Toverall agricultural output and crop yields due to vari- shows that despite the slowdown in the agricultural ous reasons (Bhalla and Singh 2009; Desai et al 2011). In the sector and higher increases in the cost of food context of persistently high food price infl ation in India over production during the post-economic reforms period the last few years, it was argued that the supply constraint causing high food prices was rooted in the slow growth of (1992–2013), food prices were relatively low compared Indian agriculture in the post-ERs period (Carrasco and to the initial (1967–80) and the maturing (1980–92) Mukhopadhyay 2012; Desai et al 2011; GoI 2012). However, a stages of the Green Revolution. This, it is argued, is clear understanding of the food price situation during the possibly due to more stable agricultural growth post-ERs period as a whole and its connection with the slowdown in agricultural growth during the same period is yet post 1991–92, higher buffer food stocks, greater to emerge. coverage of the public distribution system, and better Against this background, this paper aims to examine the responses to food price fluctuations due to import/trade trends in food price infl ation in India in relation to the growth liberalisation and a more comfortable foreign exchange of Indian agriculture pre- and post-ERs, so as to enhance our understanding of food price behaviour during the post-ERs reserves position. period, which has been a period of slow agricultural growth. For this purpose, following Bhalla (2007), Bhalla and Singh (2009), and Panagariya (2004), the growth path of India’s agri- culture sector is divided into four phases: the pre-Green Revolution period (1950–51 to 1964–65),2 the initial stage of the Green Revolution (1967–68 to 1979–80), the maturing stage (1980– 81 to 1991–92), and the post-ERs period (1992–93 to 2012–13).3 The paper is organised as follows. Section 2 presents a brief performance analysis of Indian agriculture under various agrarian policy phases in terms of growth in agricultural gross domestic product (GDP) and food output. In Section 3, the trends in wholesale price index (WPI) food infl ation witnessed during various agrarian policy periods are discussed. Section 4 offers possible reasons for the price trends that emerged under agrarian policy regimes. The last section summarises the fi nd- ings of the paper and draws policy conclusions. 2 Performance of Indian Agriculture The authors are thankful for valuable comments and suggestions from an anonymous referee of this journal and participants of seminars and 2.1 Pre-Green Revolution (1950–51 to 1964–65): At the time of conferences held at Central University of Kerala, IIM Calcutta, IIM independence, India witnessed an acute shortage of food due Kozhikode, and the National Institute of Public Finance and Policy, to the disruption caused to the agricultural sector following the New Delhi. The usual disclaimer applies. partition of British India in 1947 (Bhalla 2007; Swaminathan Sthanu R Nair ([email protected]) and Leena Mary Eapen (leenaeapen@ 2012). Partition led to loss of rich fertile lands to Pakistan and iimk.ac.in) are with the Indian Institute of Management, Kozhikode. large-scale migration of populations across the borders. The Economic & Political Weekly EPW august 1, 2015 vol l no 31 49 The Pink Professor SPECIAL ARTICLE government met the country’s immediate food requirement rate of agricultural GDP declined slightly to 2.92% pa during the through large-scale import of food aid, primarily using the PL same period (Table 1).9 480 programme of the United States (US). In addition, serious attempts were made to attain self-suffi ciency in food produc- 3 Trends in Food Prices tion by way of large public investment in agricultural infra- We examined the monthly movements (Figures 1 and 2, p 51) of structure, implementation of land reforms and rural develop- two components of WPI food infl ation (Base: 2004–05), namely, mental schemes (Bhalla 2007; Chandra, Mukherjee and primary food articles and manufactured food products, during Mukherjee 2008). the four agrarian periods described earlier to identify episodes of high and persistent food infl ation during each period, and 2.2 Initial Stage (1967–68 to 1979–80): The agrarian to calculate the average infl ation rate in each such episode stagnation during the fi rst half of the 1960s eventually led (Tables 3 and 4, p 52).10 Since most studies have suggested a to the introduction of a new high yielding varieties (HYV)– threshold level of infl ation of about 6% for India (Table 2 in seed–fertiliser strategy, popularly known as the Green Pattanaik and Nadhanael 2011) we considered the persistence Revolution, starting from 1966.4 The infl uence of this new of infl ation of 6% and above as a high infl ationary episode. The strategy on the performance parameters of Indian agriculture average infl ation rate recorded in an episode, say from June 1972 was not encouraging during the initial stage (1967–68 to to May 1975, is calculated based on the change in the average 1979–80). This is evident from the noticeable drop in the value of the WPI over this period with respect to the average value growth rate of agricultural GDP, output and yield of all the of the WPI over the corresponding period (June 1971 to May 1974) major crops except wheat during this stage (Tables 1 and 2).5 the year before. The fi ndings of our analysis are as follows: Several factors are believed to have contributed to this out- Since April 1954 India experienced 14 episodes of high food come (Bhalla 2007; EPW 1967a, 1967b). They include mainly articles infl ation (Table 3).11 On all these occasions, the impact limited crop (only wheat) and geographical coverage (only of the price build-up was broad-based, implying that almost all Punjab, Haryana and Western Uttar Pradesh) of the Green the commodity subgroups under the food articles category Revolution strategy to start with; the after effects of the 1965 were subject to high infl ation.12 The longest episode of high and 1971 India–Pakistan wars; and the oil crises of 1973–74 food articles infl ation were the 62 months from July 1979 to and 1978–79. August 1984, followed closely by 61 months from March 2008 to March 2013, and 57 months from June 1963 to February 1968. 2.3 Maturing Stage (1980–81 to 1991–92): Consequent to the The infl ationary episode that had the highest average food spread of the HYV–seed–fertiliser strategy to more crops and articles infl ation of 20.22% was during the 36-month period almost all geographical areas, India’s agrarian economy wit- from June 1972 to May 1975. nessed a revival during the Table 1: Compound Annual Growth Rates During the pre-Green Revolution period, high food articles of Gross Domestic Product (GDP) and 1980s. Compared to the Agricultural GDP (Base: 2004–05) (%) price infl ation occurred on four occasions (Table 3). The aver- initial stage of the Green Period Total Agricultural age infl ation recorded during these infl ationary episodes Revolution, the growth GDP GDP ranged from 8.5% to over 15%. In the 13 years covering the rate of agricultural GDP, 1950–51 to 1964–65 3.95 2.66 initial stage of the Green Revolution, India experienced three 1967–68 to 1979–80 3.45 2.19 output and yield of a ma- 1980–81 to 1991–92 5.21 3.09 Table 2: Compound Annual Growth Rate of Production and Yield of jority of crops recorded 1992–93 to 2012–13 7.01 2.92 Various Food Commodities (%) Items 1950–51 to 1967–68 to 1980–81 to 1992–93 to an improvement between Data for 2010–11 are second revised estimates 1964–65 1979–80 1991–92 2012–13 1980–81 and 1991–92 (RE), for 2011–12 are first RE and for 2012–13 are provisional. Output Yield Output Yield Output Yield Output Yield (Tables 1 and 2). The GDP Source: Handbook of Statistics on Indian Economy Total foodgrains 3.54 2.12 2.16 1.73 2.74 3.01 1.58 1.57 growth fi gure of 3.09% (HSIE) 2012–13, Reserve Bank of India (RBI). Cereal 3.76 2.43 2.47 2.08 2.87 3.20 1.59 1.68 pa achieved by the agricultural sector during this period is the Rice 4.35 2.86 1.95 1.18 3.71 3.12 1.38 1.34 highest till date. Another landmark achievement was the Wheat 4.27 1.53 5.48 2.30 3.63 3.24 1.93 1.12 emergence of yield as the predominant contributor to food- Coarse cereals 2.75 1.68 0.72 1.81 –0.01 1.73 1.45 2.58 6 output growth.
Load more

Recommended publications
  • Working Paper No: 449
    WORKING PAPER NO: 449 Inflation Targeting in India Saakshi Mahajan PGP Student Indian Institute of Management Bangalore Bannerghatta Road, Bangalore – 560076 [email protected] Souvik Kumar Saha PGP Student Indian Institute of Management Bangalore Bannerghatta Road, Bangalore – 560076 [email protected] Charan Singh RBI Chair Professor Economics & Social Science Indian Institute of Management Bangalore Bannerghatta Road, Bangalore – 5600 76 Ph: 080-26993818 [email protected] Year of Publication –February 2014 1 Inflation Targeting in India1 Abstract: Inflation targeting (IT), since its inception, has been a topic of much debate for economists all around the world. In this paper, the suitability of inflation targeting for an emerging economy like India is explored, pitching it against the multi-variable approach currently being followed. One of the foremost challenges in the present context of global economic crisis is the debate whether priority should be accorded to IT or financial stability. Also, in India, there is still another dimension and that is, which of the multiple price indices would be most appropriate for fixing as an anchor of IT. Therefore, this paper also evaluates different forms of CPI, WPI and PPI in order to find which amongst them would be the best indicator of inflation in the Indian scenario. Through analysis of conditions prevalent in India, this paper justifies why inflation targeting would not be an appropriate policy for India at this juncture, and recommends certain changes in the present multi-variable approach that would make it more robust and effective. Keywords: Inflation targeting, price indices, multi-indicator policy, transmission mechanism 1The authors are grateful to Mr.
    [Show full text]
  • Banking Sector Reforms and the Goals of Nationalised Commercial Banks in India
    fșă Theoretical and Applied Economics Volume XXVII (2020), No. 2(623), Summer, pp. 241-262 Banking Sector Reforms and the Goals of Nationalised Commercial Banks in India Kubendran NARAYANASAMY NMIMS University, India [email protected] Abstract. The main aim of the study is to analyse the role of Nationalised Commercial Bank (NCB) on economic growth and development in India during pre and post-reform periods (Restrictive and liberalised regime). The study also aims to analyse the performances and associations of nationalised commercial banks with the RBI in the same period. For this purpose, the study first uses Augmented-Dickey Fuller unit root test. After assessing stationary conditions, the study uses Engel-Granger Causality test and Trend line analysis. Based on the empirical results, the study found that the role of NCB on economic growth is higher in the post-reform period compared to the pre-reform period. But their role in poverty eradication and employment generation is less in the post-reform period even though the average GDP growth rate is high in the post-reform period. Similarly, the performances of NCBs are also declining due to the increasing trend in their NPAs. The study also found that the monetary policy is not much effective in India, especially after 2000 where fall in the interest rate failed to influence GDP. So the study strongly recommended frequent interference and instructions of RBI to enhance the performances of NCBs and the effectiveness of monetary policy to achieve macroeconomic goals. Keywords: monetary policy, non-performing asset, money supply, granger causality, poverty, unemployment, GDP growth.
    [Show full text]
  • Impact of Inflation and Gdp on Cnx Nifty
    IMPACT OF INFLATION AND GDP ON CNX NIFTY *Dr. J K Raju **Mr. Manjunath B R ***Mr. Pradeep Kumar S Abstract : Inflation and GDP are the two main important macro-economic variables. GDP is an economic indicator of the market value of all finished goods and services produced over a period (Quarterly or yearly) of time. There has been a decline in the GDP growth rate in the year 2017 compared to previous year. Several factors including global situation are responsible for the decline in GDP growth rate. Inflation is a continual growth in the universal worth of goods and services in an economy over a period of time. When the price level increases, each component of currency buys fewer goods and services. This paper mainly deals with the impact of Inflation and GDP on Indian market that is National stock exchange (NSE). For this we have collected 10 years quarterly data and also applied E-views statistical package. Unit root test for stationary, co-integration test, vector error correction model, and granger causality test, were conducted. Keywords: Inflation, Gross domestic product, National stock exchange, E-views. Introduction Gross domestic product (GDP) is an Economic indicator of the market value of all The National stock exchange (NSE) was finished goods and services produced over a established in 1992 as a tax-paying company period (Quarterly or yearly) of time. Gross and was recognized as a stock exchange in domestic product includes all private and 1993 under the Securities Contracts public consumption, government outlays, and (Regulation) Act, 1956. NSE commenced investments.
    [Show full text]
  • Understanding Inflation in India
    NBER WORKING PAPER SERIES UNDERSTANDING INFLATION IN INDIA Laurence Ball Anusha Chari Prachi Mishra Working Paper 22948 http://www.nber.org/papers/w22948 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 December 2016 Prepared for the Brookings-NCAER India Policy Forum. We would like to thank Pami Dua, Subir Gokarn, Ken Kletzer, and participants at the India Policy Forum conference for comments, and Edmund Crawley, Manzoor Gill, Jianhui Li, Wasin Siwasarit, and Ray Wang for excellent research assistance. The views represent those of the authors and not of the Reserve Bank of India, any of the institutions to which the authors belong, or the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer-reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2016 by Laurence Ball, Anusha Chari, and Prachi Mishra. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. Understanding Inflation in India Laurence Ball, Anusha Chari, and Prachi Mishra NBER Working Paper No. 22948 December 2016 JEL No. E31,E58,F0 ABSTRACT This paper examines the behavior of quarterly inflation in India since 1994, both headline inflation and core inflation as measured by the weighted median of price changes across industries. We explain core inflation with a Phillips curve in which the inflation rate depends on a slow-moving average of past inflation and on the deviation of output from trend.
    [Show full text]
  • The Determinants of Inflation in India: the Bounds Test Analysis
    International Journal of Economics and Financial Issues ISSN: 2146-4138 available at http: www.econjournals.com International Journal of Economics and Financial Issues, 2016, 6(2), 544-550. The Determinants of Inflation in India: The Bounds Test Analysis Md Qaiser Alam1, Md Shabbir Alam2* 1Department of Economics, D.S (P.G) College, Aligarh, Uttar Pradesh, India, 2Department of Accounting & Finance, CCBA, Dhofar University, Oman. *Email: [email protected] ABSTRACT India is facing a fast rise in the general price level for the last couple of years. This paper seeks to empirically examine the sources of inflation in India both in the long-run and in the short-run by using the co-integration method developed by Pesaran et al. (2000). The empirical findings suggests that in the long-run money supply (MS), depreciation of the rupee and supply bottlenecks puts a pressure on the domestic price level by causing inflation to rise in the country. The analysis reveals that in the long-run domestic factors as monetary growth and supply bottlenecks dominates the external factors for a rise in the domestic prices in the economy. The short-run analysis also reveals that domestic factor MS and supply bottlenecks dominate the external factor as a measure cause for a persistent rise in the price level in the country. The supply bottlenecks are though a significant factor in the short-run, but its importance in the long-run is relatively small. Keywords: Inflation, Money Supply, Exchange Rate, World Price, Gross Domestic Product Gap, Bounds Test, Error Correction Model JEL Classifications: E31, E51, D51, F43 1.
    [Show full text]
  • Inflation Targeting in India: Select Issues
    IIMB-WP N0. 475 WORKING PAPER NO: 475 INFLATION TARGETING IN INDIA: SELECT ISSUES Charan Singh RBI Chair Professor Economics & Social Science Indian Institute of Management Bangalore Bannerghatta Road, Bangalore – 5600 76 Ph: 080-26993818 [email protected] Year of Publication – November 2014 1 IIMB-WP N0. 475 Inflation Targeting in India: Select issues Charan Singh1 Abstract The adoption of inflation targeting in India has been a much debated topic which also becomes a challenge for the emerging economy. Though inflation targeting has already been adopted in many emerging and advanced countries, acceptability in India is a matter of concern. The paper argues that an emerging country like India needs to consider the composition of consumer price index; state of macro econometric models; and young demographics, unemployment rate and lack of social security before adopting inflation targeting. To modernize the monetary policy framework, India could consider introducing regular review of the regional economy; instituting a Monetary Policy Committee; and separating debt from monetary management, the paper argues. Keywords: Monetary policy framework, inflation, inflation targeting, debt management 1 RBI Chair Professor of Economics, IIM Bangalore. Views are personal. The author would like to thank Jafar Baig, Sriramjee Singh, Sharada Shimpi and Shara Bhattacharjee for their research assistance. 2 IIMB-WP N0. 475 Introduction Inflation Targeting could be the next major policy measure adopted in India as the proposal is under active consideration by the Reserve Bank of India (RBI) and the Government of India (GOI). In recent years, there has been a debate on the monetary policy framework in the country, basically anchored around the philosophy of adopting inflation targeting (IT) in India.
    [Show full text]
  • CPI Inflation: FY12-FY21
    CPI Inflation: FY12-FY21 May 12, 2021 I Economics Headline inflation based on Consumer price index (CPI) has grown at a CAGR of 5.8% during the last ten years (i.e., FY12 to FY21). This can be viewed in the context of the Monetary Policy Committee’s approach to flexible inflation targeting from 2016 onwards with the aim of maintaining inflation at 4% with a band of 2% on both sides. Inflationary pressures have rebounded with retail inflation rising to 6.2% during FY21, exceeding the 6% limit. This has been manifested in both food inflation and core inflation. Higher food prices were due to supply shortfalls as in case of pulses as well as global trends in case of edible oils. Further, periodic disruptions caused by monsoon-related issues for vegetables caused inflation to increase sharply. Core inflation became fairly sticky as prices of various manufactured products and services increased post the unlock process. Global trends Pandemic and resultant lockdowns/restrictions imposed globally in order to restrict the spread of infections resulted in slowing down of economic activities. Global commodity and crude oil prices moved downward owing to bleak demand prospects. Central Banks turned accommodative to extend support to the economies hard-hit by the disruptions as inflation remained benign. On the domestic front, imposition of a nation-wide lockdown in March 2020 resulted in firming up of prices on the back of rising cost-push inflation and supply side disruptions. Declining global crude oil prices were partly offset by an increase in taxes which ensured that the benefit of lower prices did not fully reach the consumer.
    [Show full text]
  • Chapter 39 PRICES "Inflation Is the Form of Taxation Which the Public
    Chapter 39 PRICES "Inflation is the form of taxation which the public find hardest to evade."- Keynes 39.1 Background: Price trends reflect a complex phenomenon of demand-supply interaction, pattern and form of state intervention through determining the level of money supply, direct and indirect tax structure and the relative importance of different components of the national production basket which, in turn has been influenced by the investment priorities and policies of the yester years. Inflation, a related term in economic lexicon, indicating sustained rise in general level of prices of goods and services , assumes significance in economies ridden with disparities because of large many experiencing the phenomenon of being ‘ priced out ‘ . In situation of high inflation, with a variety of goods and services getting out reach for many, the corrosion in the well being begins to undercut the achievements in economic growth. Even though it affects all by eroding the purchasing power of income, raising the cost of living and lowering the real value of savings, it is the poor who are most vulnerable to inflation as they do not have any effective hedge against it. Hence inflation has always been one of the most closely monitored macroeconomic indicators. 39.2 The changes in prices over a period of time can be gauged by the statistical device of index number of prices. The price index can be either at the wholesale level (WPI) or at the level of the retail end of marketing channel or Consumer Price (CPI). Inflation Measures : Conceptual issues 39.3 India has a rich tradition of collection and dissemination of price statistics dating back to 1861 when the Index of Indian Prices was released.
    [Show full text]
  • Explaining Inflation in India
    EXPLAINING INFLATION IN INDIA: † THE ROLE OF FOOD PRICES Prachi Mishra Research Department, International Monetary Fund‡ Devesh Roy International Food Policy Research Institute October 31, 2011 Abstract This paper conducts a forensic examination of inflation in India with a focus on food price inflation, using a disaggregated high-frequency commodity level dataset spanning the last two decades. First, we document stylized facts about the behavior of overall inflation in India. We establish that low inflation has historically been a rare occurrence in the Indian economy in the last two decades; the long-term trend in the inflation rate exhibits a U-shaped pattern with a structural break in the trend in 2000 and an inflection point in 2002. The long-term trend in food inflation has followed a pattern similar to overall inflation. Domestic and international food price inflation rates have been moderately correlated, though there is significant variation across commodities based on their tradability. Furthermore, we find food price inflation to be consistently higher than non-food, quite persistent, and having a significant pass-through to non-food inflation. Further, the price of food relative to non-food co-moves strongly with aggregate inflation rate. Next, we explicitly quantify the contribution of specific commodities to food price inflation. We find that animal source foods (milk, fish), processed food (sugar, edible oils), fruits and vegetables (e.g. onions) and cereals (rice and wheat) are the primary drivers of food price inflation. Finally, we conduct case studies of some of the top contributors to food price inflation. Combining the insights from macro as well as micro analyses, the paper suggests specific policy implications.
    [Show full text]
  • Strategy | INDIA
    Strategy | INDIA 2011 Outlook NOMURA FINANCIAL ADVISORY AND SECURITIES (INDIA) PRIVATE LIMITED Prabhat Awasthi +91 22 4037 4180 [email protected] Nipun Prem +91 22 4037 5030 [email protected] TOP DOWN ANCHOR REPORT Under the weather Stocks for action We reckon that 2011F will be a year of below-average returns for Indian equities. Our top BUY calls are MM and PF, as Market performance is likely to be shaped by a macroeconomic environment consumption and rural demand plays, punctuated by wage pressures, rising commodity prices, return of inflationary pressures, and TATA and CAIR, for their exposure tight liquidity (in the first half, at least), slowing growth momentum, a hesitant recovery to global commodity prices. ACEM and in the investment cycle, below-average earnings growth, downward sticky interest rates, HPCL are our top REDUCE calls. tighter monetary policy and somewhat muted government expenditure — all this in the backdrop of strong domestic consumption and below-trend global economic growth. We Stock Rating Price (INR) PT M&M (MM IN) BUY 789 892* favour a defensive bias when approaching sectors for next year. We recommend a Pantaloon (PF IN) BUY 389.5 553 relative Underweight stance on rate cyclicals, construction and cement, and a relative TATA Steel (TATA IN) BUY 624 846 Overweight stance on consumer, pharma, power, oil & gas, metals and IT services. Our Cairn India (CAIR IN) BUY 327 370* Ambuja Cements REDUCE 137.9 113 top BUY calls for next year are Mahindra & Mahindra, Pantaloons, Tata Steel and Cairn. (ACEM IN) Our top REDUCE calls are Ambuja Cements and HPCL.
    [Show full text]
  • The Food Price Channel: Effects of Monetary Policy on the Poor in India
    The Food Price Channel: Effects of Monetary Policy on the Poor in India Kuhelika De∗ November, 2016 Abstract Poverty and hunger have been largely ignored in the practice and conduct of mon- etary policy. This paper studies the impact of monetary policy on food consump- tion distribution of households in India, particularly focussing on the subsistence food consumption of poor households and inequality. Using household survey data from 1996:Q1 to 2013:Q4, I estimate the dynamic effects of monetary policy shocks on rela- tive food prices and the distribution of food consumption in rural and urban India from a dynamic common factor model (Bernanke, Boivin, and Eliasz, 2005 and Stock and Watson, 2010), and identify monetary policy shocks using the sign restriction approach of Uhlig (2005). I find that an expansionary monetary policy shock increases relative food prices, reduces the subsistence food consumption of poor households, and raises inequality across households in food consumption. This paper provides evidence of the impact of a \food price channel" of monetary policy on poor households in India. To the best of my knowledge, this is the first study to empirically investigate the impact of monetary policy on poor households in India. This study may hold important policy implications for Indian policymakers as well as those in similar low-income countries. Keywords: Monetary Policy, Food Prices, Food Subsistence, Poverty, Inequality, De- velopment JEL Classification Numbers : D63, E31, E5, E63, I32, O11, O23 ∗Department of Economics, University of Georgia, email: [email protected]. I am sincerely grateful to William D. Lastrapes for his invaluable advice, guidance and support.
    [Show full text]
  • Monetary Policy Transmission in India
    Monetary policy transmission in India Rakesh Mohan1 Key to the efficient conduct of monetary policy is the condition that it must exert a systematic influence on the economy in a forward-looking sense. A priori economic theory backed by some empirical evidence has identified the main channels through which monetary policy impacts its final targets, viz, output, employment and inflation. Broadly, the vehicles of monetary transmission can be classified into financial market prices (eg, interest rates, exchange rates, yields, asset prices, equity prices) or financial market quantities (money supply, credit aggregates, supply of government bonds and foreign denominated assets). It is recognized that, whereas these channels are not mutually exclusive, the relative importance of each channel may differ from one economy to another depending on a number of factors, including the underlying structural characteristics, the state of development of financial markets, the instruments available to monetary policy, the fiscal stance and the degree of openness. Traditionally, four key channels of monetary policy transmission are identified, viz, interest rate, credit aggregates, asset prices and exchange rate channels. The interest rate channel emerges as the dominant transmission mechanism of monetary policy. An expansionary monetary policy, for instance, is expected to lead to a lowering of the cost of loanable funds, which, in turn, raises investment and consumption demand and should eventually be reflected in aggregate output and prices. Monetary policy also operates on aggregate demand through changes in the availability of loanable funds, ie, the credit channel. It is, however, relevant to note that the “credit channel” is not a distinct, free-standing alternative to the traditional transmission mechanism but should rather be seen as a channel that can amplify and propagate conventional interest rate effects (Bernanke and Gertler, 1995).
    [Show full text]