Financial Frictions, Bank Intermediation and Transmission Mechanism of Monetary Policy: Evidence from Indian Economy


Date(s) - 03/09/2019
3:15 pm - 5:00 pm


Abstract: How do the frictions in the financial market determine the transmission of monetary policy in the emerging market and developing economies? We investigate this question using India as the country for analysis. We adopt a New Keynesian business cycle model with bank intermediation like Gerali et al. (2010) and extend it by Indian economy-specific features. Using Bayesian methodology, we estimate the model with quarterly macroeconomic data of Indian economy (1999: Q1 – 2015: Q3). Our baseline model explains the co-movements of interest rates, incomplete pass-through and sluggish adjustment mechanism of the macroeconomic and financial variables for a positive shock to the policy interest rate. The model underscores the critical role of liquidity-constrained and collateral-constrained households, liquidity effect of savers, and interest rate rigidity in the transmission mechanism. It also predicts that targeting financial stability through monetary policy rule may not be appropriate for economic stabilization.

Comments are closed.