Asymmetric effects of monetary policy and financial accelerator: Evidence from India

Abstract

This paper analyzes the asymmetric effects of monetary policy shocks during low and high financial stress regimes in India. We explore the asymmetric effects through various monetary policy transmission channels, namely, interest rate, credit, asset prices, exchange rate, and expectations channels, using threshold vector autoregression (TVAR) models. Financial Stress Index (FSI) is used in the TVAR estimations as the threshold variable that endogenizes the regime-switching. We use a compressive FSI based on the dynamic conditional correlation-generalized autoregressive conditional heteroscedasticity (DCC-GARCH) method. The empirical findings indicate that a contractionary monetary policy shock through various channels has a stronger and more persistent effect on macroeconomic goal variables, output, and inflation during high financial stress than in a low financial stress regime. An expansionary monetary policy shock also shows a more significant effect on output during a high financial stress regime. Also, we found a stronger financial accelerator effect during high financial stress. This finding supports the literature that argues for the emergence of a stronger financial accelerator effect during financial stress. Finally, using nonlinear historical decompositions, we find that interest rate shocks contribute significantly to macroeconomic fluctuations in India.