Dove or Hawk? characterizing monetary regime switches during financial liberalization in India

Hutchison, Michael and Sengupta, Rajeswari and Singh, Nirvikar (2011): Dove or Hawk? characterizing monetary regime switches during financial liberalization in India.

Abstract

The last decade has seen a worldwide move by emerging markets to adopt explicit or implicit inflation targeting regimes. A notable and often discussed exception to this trend, of course, is China which follows pegged exchange rate regime supported by capital controls. Another major exception is India. It is not clear how to characterize the monetary regime or identify the nominal monetary anchor in India. Is central bank policy in India following a predictable rule that is heavily influenced by a quasi inflation target? To address this point, we investigate monetary policy regime change in India using a Markov switching model to estimate a time-varying Taylor-type rule for the Reserve Bank of India. We find that the conduct of monetary policy over the last two decades can be characterized by two regimes, which we term ‘hawk’ and ‘dove.’ In the first of these regimes, the central bank reveals a greater relative (though not absolute) weight on controlling inflation vis-à-vis narrowing the output gap. The central bank was in the “dove” regime about half of the sample period, during these episodes focusing more on the output gap and exchange rate targets to stimulate exports, rather than on moderating inflation. India is following its own direction in the conduct of monetary policy, seemingly not overly influenced by the emphasis on quasi-inflation targeting seen in many emerging markets.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary policy; Regime switches; Central banking; Inflation targeting
• Subjects: E - Macroeconomics and Monetary Economics > E0 - General; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; F - International Economics > F3 - International Finance; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit; E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates

References

Aizenman, J., Hutchison, M. and Noy, I. 2008, Inflation Targeting and Real Exchange Rates in Emerging Markets, NBER Working Paper 14561.

Assenmacher-Wesche, K., 2005, Estimating Central Banks’ preferences from a time-varying empirical reaction function, European Economic Review 50, 1951-1974.

Burdekin, R., and Siklos, P. (2008). What has driven chinese monetary policy since 1990? Investigating the People’s Bank’s Policy Rule. Journal of International Money and Finance, 27(September (5)), 119–141.

Clarida, R., Gali, J. and M. Gertler, 2000, Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory, Quarterly Journal of Economics 115, 147-180.

Engel, C., and Hamilton, J. D., 1990, Long swings in the dollar. Are they in the data and do markets know it? American Economic Review 80, 689 – 713.

Frommel, M., Macdonald, R. and Menkhoff, L., 2005, Markov switching regimes in a monetary exchange rate model, Economic Modelling 22, 485 – 502

Giannoni, M., Woodford, M., 2002, Optimal Interest-Rate Rules: II. Applications, Working Paper, Department of Economics, Princeton University.

Glick, R. and M. Hutchison, 2009, Navigating the Trilemma: Capital Flows and Monetary Policy in China, Journal of Asian Economics 20, 205-224.

Goldfeld, S.M., and Quandt, R.E., 1973, A Markov model for switching regressions, Journal of Econometrics 1, 3 – 16.

Gonçalves, C.E.S., and J.M. Salles, 2008. Inflation targeting in emerging economies: What do the data say? Journal of Development Economics 85, 312-318.

Hamilton, J. D., 1989, A new approach to the economic analysis of non-stationary time series and the business cycle. Econometrica 57 (2), 357 – 384.

Hutchison, M., Kendall, J., Pasricha, G., Singh, N., 2010, Indian Capital Control Liberalization: Estimates from NDF Markets, UCSC Working Paper

Mohan, R., 2006a, Monetary policy and exchange rate frameworks - the Indian experience, Presentation at the Second High Level Seminar on Asian Financial Integration organized by the International Monetary Fund and Monetary Authority of Singapore, Singapore.

Mohan, R., 2006b, Evolution of Central Banking in India, based on lecture delivered at a seminar organized by the London School of Economics and the National Institute of Bank Management at Mumbai, India, on January 24, 2006.

Mohanty, M.S., and M. Klau, 2005, Monetary Policy Rules in Emerging Market Economies: Issues and Evidence, in Monetary Policy and Macroeconomic Stabilization in Latin America, Rolf J. Langhammer and Lucio Vinhas de Souza (Eds.), Berlin: Springer-Verlag, 205-245.

Ouyang, A., Rajan, R. & Willett, R. (2010). China as a reserve sink: the evidence from offset and sterilization coefficients. Journal of International Money and Finance. 29 (September), 951-972.

Owyang, M. and Ramey, G., 2004, Regime Switching and Monetary Policy Measurement, Journal of Monetary Economics 51, 1577–1597

Patnaik, I. 2007. India's currency regime and its consequences. Economic and Political Weekly, March.

Panagariya, A., 2008, India: The Emerging Giant, New York, Oxford University Press

Perlin, M., 2009, ‘MS_Regress-A package for Markov Regime Switching Models in Matlab’ Matlab Central: File exchange.

Rose, A., 2007, A Stable International Monetary System Emerges: Inflation Targeting is Bretton Woods, Reversed, Journal of International Money and Finance 26(5), 663–681.

Shah, A., 2008, New issues in Indian macro policy. In T. N. Ninan, editor, Business Standard India. Business Standard Books, 2008

Taylor, J. B., 1993, Discretion versus Policy Rules in Practice, Carnegie-Rochester Conference Series on Public Policy 39, 195-214.

Taylor, J. B., 2001, The Role of the Exchange Rate in Monetary Policy Rules, American Economic Review Papers and Proceedings 91, 263-67.

Virmani, V., 2004, Operationalising Taylor-type rules for the Indian economy, Technical report, Indian Institute of Management, Ahmedabad.

Woodford, M., 1999, Optimal Monetary Policy Inertia, Working Paper, Department of Economics, Princeton University

Woodford, M., 2001, The Taylor Rule and Optimal Monetary Policy, American Economic Review 91(2), 232-237