Monetary Policy Credibility, Real Exchange rate and Exchange rate pass-through in India

Abstract

Purpose: The purpose of the present study is three-fold. Firstly, it investigates whether the nominal exchange rate is fulfilling its role for macroeconomic stabilisation? Second, it examines whether the direction of exchange rate change matter for exchange rate pass-through. Third, it investigates the long-standing conjecture in macroeconomics which relates the decline in pass-through to monetary policy credibility. Design: The Autoregressive distributed lag model is used. For, the first question, the study uses the disaggregate level data of newly introduced consumer price index- combined (CPI-C). The comparison of pass-through between tradable and non-tradable goods is used. For the second issue and third issues, the data of main groups is only used. Findings: The study finds that exchange rate in India fulfils the role of macroeconomic stabilisation as pass-through is higher for tradable than non-tradable goods. The impact of direction of exchange rate on pass-through is found mixed. The monetary policy credibility matters for the pass-through for the CPI-C. However, for its groups, the evidences are mixed. Implications: The issue of pass-through is important for the macroeconomic stability and monetary policy credibility. If the pass-through does not vary between tradable and non-tradable components then nominal exchange rate is not fulfilling its role of macroeconomic stability. Originality: The paper investigates the often-neglected issues of pass-through in the Indian context. Previous studies have mostly focused on aggregate index, our study focus on disaggregated data. JEL Classification E31, E52, E58, F3, F41