Monetary Policy Efficacy Pre- and Post-COVID-19 Pandemic: Evidence from India

Abstract

Inflation has run higher than the targets of central banks across the globe post the COVID-19 pandemic. India is no exception. The central banks have responded through synchronous interest rate increases. The efficacy of policy measures has been mixed though, underscoring country-specific differences in sources of inflation and monetary transmission across channels. Employing a time-varying vector autoregression framework, we analyse the interaction with output, interest rate and inflation in India. We employ quarterly data on real GDP growth, Wholesale Price Index (WPI) growth, Consumer Price Index (CPI)-Industrial workers (CPI-IW) growth and 1 year-treasury bill rate, from 2005–2006 Q1 to 2021–2022 Q4. We use two measures of inflation to get the dynamics of retail and wholesale inflation. We contrast the interactions of aforesaid variables through time-varying impulse response functions (IRFs) during two big macroeconomic events, namely, the subprime crisis of 2008 and COVID-19 pandemic in 2020. During the subprime crisis in 2008, we saw negligible response in the short, medium and long run. During the COVID-19 period, we find all time-varying IRFs are synchronized. The response of CPI-IW to the interest rate shock is very different from that of WPI, underscoring differences in the composition of these price measures. A shock from the interest rate keeps the CPI-IW stable at best; we do not see any reduction in CPI-IW across the short, medium and long run. The reaction of GDP growth to interest rate shock is rather flat during both the subprime crisis and COVID-19 in the short, medium and long run, pointing towards potential monetary policy ineffectiveness in stimulating the growth.