Monetary Policy and Inflation in India: A Structural VAR Analysis

TLDR: In this paper, a Vector Auto-Regression (VAR) analysis of inflation and monetary policy is presented, which identifies monetary policy shocks in a benchmark recursive structure of VARs with two alternative inflation measures, viz., headline WPI and core inflation measure.

Abstract: This paper provides a Vector Auto-Regression (VAR) analysis of inflation and monetary policy. It identifies monetary policy shocks in a benchmark recursive structure of VARs with two alternative inflation measures, viz., headline WPI and core inflation measure. Unlike the results in case of WPI, the response of core prices declined swiftly, following a positive call money interest rate shock. Thus, the interest rate channel is stronger for core prices. It is pertinent as RBI currently operates its monetary management through interest rate channel. The study checks robustness of results of the benchmark recursive model against alternative ordering and non-recursive identification schemes. Finally, a core price targeting scenario is generated in the benchmark VAR model with non-recursive identification scheme.