Monetary Policy Disturbance in India: The Relationships Among Money, Output and Prices

Abstract

The study examines the relationships among money supply, output and prices. Quarterly data were sourced from the Federal Reserve Bank of St. Louis, which spanned from 1996 Q2 to 2019 Q1. Four variables were included in the study: GDP, inflation (Consumer Price Index [CPI]) and two measures of money supply (M1 and M3). The findings of the study reveal that money supply is correlated with India’s output as well as inflation. Johansen’s test of co-integration reveals the existence of a long-term relationship among the variables. Another striking finding of this study is that neither M1 nor M3 could cause output (GDP) in the short run, but both Granger-cause inflation in the short run, which may be attributed to the output growth capacity limit of the country. The monetary policy disturbance in relation to other variables was examined through a structural vector autoregressive (SVAR) model that indicates that the two measures of money supply exert a positive impact on GDP. Similarly, the finding also shows that a monetary policy shock from the two measures of money supply causes a positive and continuous increase in inflation in India. Thus, money supply measure M3 is a potential indicator of movement in India’s output; hence the monetary authority should be mindful of inflation while targeting output expansion through money supply.