Modeling Inflation in India: The Role of Money

Kishor, N. Kundan (2009): Modeling Inflation in India: The Role of Money.

Abstract

This paper studies the role of the real money gap- the deviation of real money balance from its long-run equilibrium level- for predicting inflation in India. Using quarterly data on manufacturing inflation from 1982 to 2007, we find that the real money gap is a significant predictor of inflation in India. Our results show that this variable is a better predictor of future inflation at quarterly horizon than the deviation of broad money growth from its target for the whole sample period. We also document a break in the overall predictability of inflation in the last quarter of 1995. We find that except for the real money gap, the forecasting power of other predictors under study has declined considerably after 1995.

• Item Type: MPRA Paper
• Language: English
• Keywords: Inflation. Monetary Policy, Indian Economy
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E31 - Price Level ; Inflation ; Deflation; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy

References

Andrews, Donald W.K. (1993),"Tests for Parameter Instability and Structural Change with Unknown Change Point," Econometrica, 61, 821--856.

Andrews, Donald W.K. and W. Ploberger (1994),"Optimal Tests When a Nuisance Parameter Is Present Only Under the Alternative," Econometrica, 62, 1383--1414.

Bahmani-Oskooee, Mohsen (1996), "The Black Market Exchange Rate and Demand for Money in Iran," Journal of Macroeconomics, 18, 171--76.

Balakrishnan, P. (1992), "Industrial Price Behaviour in India: An Error-Correction Model," Journal of Development Economics, 37, 309-326.

Buragohain, T. (1997),"The Role of Sectoral Prices in Indian Inflation," Indian Journal of Quantitative Economics, 89-102.

Callen, Tim and Dongkoo Chang (1999),"Modeling and Forecasting Inflation in India," IMF Working Paper.

Chand, S. (1996),"Fiscal and Other Determinants of Indian Inflation Rate," National Institute of Public Finance and Policy Working Paper No 7.

Coe, D. and J. McDermott (1997),"Does the Gap Model Work in Asia," IMF Staff Paper, 44(1), 59-80.

Engle, Robert F. and Clive J. Granger (1987),"Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, 55, 251-276.

Fuhrer, Jeffrey C. (1997),"The (Un)Importance of Forward-Looking Behavior in Price Specifications," Journal of Money, Credit, and Banking, 29, 338-350.

Gerlach, Stefan and Lars E.O. Svensson (2003),"Money and Inflation in the Euro Area: A Case for Monetary Indicators," Journal of Monetary Economics, 50(8), 1649-1672.

Hallman, Jeffrey J., Richard D. Porter, and David H. Small (1991),"Is the Price Level Tied to M2 Monetary Aggregate in the Long-Run?," American Economic Review, 81, 841-858.

Hansen, Bruce E. (1997),"Approximate asymptotic p-values for structural change tests," Journal of Business and Economic Statistics,15, 60-67.

Nachane, D.M. and R. Lakshmi (2002),"Dynamics of Inflation in India- a P-star Approach," Applied Economics, 34, 101-110.

Nelson, Charles R. and Myung J. Kim (1993),"Predictable Stock Returns: The Role of Small Sample Bias," The Journal of Finance, 48, 641-661.

Rodrik, Dani and Arvind Subramanian (2004),"From `Hindu Growth' to Productivity Surge: The Mystery of the Indian Growth Transition," NBER Working Paper, 10376.

Sriram, Subramanian S. (2001),"A Survey of Recent Empirical Money Demand Studies," IMF Staff Papers, 47(3), 334-365.

Stock, James H. and Mark W. Watson (2007),"Why Has U.S. Inflation Become Harder to Forecast?," Journal of Money, Banking, and Credit, 39(1), 3-33.

Svensson, Lars E.O. (2000),"Does the P* Model Provide any Rationale for Monetary Targeting?," German Economic Review, 1, 69-81.

Todter, Karl-Heinz and Hans-Eggert Reimers (1994),"P-Star as a Link Between Money and Prices in Germany," Weltwirschaftliches Archiv, 130, 273-289.