Inflation targeting in India

Abstract

This thesis is an attempt to analyze the suitability of inflation targeting as a monetary newlinepolicy regime for India. The successful adoption of inflation target depends on the newlinefulfilment of certain preconditions and careful analysis of existing state of affairs in newlinethe economy. These preconditions relate to potential features of emerging economies newlineas weak fiscal regimes, the risks associated with poorly regulated financial system and newlinelarge external shocks, each of which can hinder the use of inflation target. Thus, each newlineof these problems may lead to a form of dominance namely fiscal, financial and newlineexternal. Further, due to peculiar nature of Indian economy in the form of many newlinestructural bottlenecks, there may be one other form of dominance namely structural newlinedominance. Chapter one presents a detailed sector-wise analysis of Indian economy newlineand how far India is close to fulfilling the preconditions for inflation targeting. The newlinenext chapter builds a short-run vector autoregression model of monetary policy and newlineuses this model to identify monetary policy shocks. The response of economy to these newlineshocks was used to determine the appropriate theoretical framework for conducting newlinemonetary policy experiments. This chapter also builds a hypothetical scenario of newline inflation targeting in the above VAR model to see how this regime would work for newlineIndia. This hypothetical scenario was implemented using the monetary policy newlineinstrument to react only to inflation contemporaneously or in other words, monetary newlinepolicy instrument is set after looking at current values of inflation only. The newlinehypothetical inflation targeting scenario emphasizes the importance of exchange rate newlinechannel of monetary transmission mechanism in India. The last chapter formulates a newlinesimple IS-AS-UIP framework for India broadly based on the conclusions of VAR newlinemodel. This model was then estimated and used to compare the different cases of newlinestrict and newline