Asymmetric effects of monetary policy: evidence from India

Abstract

This paper analyzes the asymmetric effects of monetary policy on the economy. The asymmetric effects of the monetary policy may arise due to the state of the economy, the direction of the shock and the magnitude of the shock. To capture these asymmetric effects, we employed a novel methodology viz nonlinear Local Projections Method. From our analysis for the period from $1996Q_{2}$ to $2020Q_{1}$, it is observed that there is significant asymmetry in the effects of monetary policy on Indian economy. The asymmetric effects are mainly due to the state of the economy (expansion/recession) and the direction of the shock (expansionary shock/contractionary shock). Further, it is observed that the effects of monetary policy on output are stronger during expansion compared to recession and expansionary shocks have stronger effect on inflation compared to contractionary shocks. When both the sign of the shock and the state of the economy are taken together, it is observed that contractionary shocks during expansion are more effective in affecting the real economy while expansionary shocks during recession significantly affect inflation. Compared to large shocks, small monetary shocks are found to be more effective. We conclude by arguing that the effects of monetary policy are significantly asymmetric and using a symmetric framework may lead to inaccurate and misleading conclusions.

7 Appendix

1.1 7.1 A

We extend Eq. (6) by incorporating the sign of the shock into Eqs. 8 and 9. The aim is to analyze the effects of monetary policy using both the sign of the policy shock and the state of the economy. In Eq. (8), we analyze the effect of contractionary monetary shock during the expansion and contraction of the economy. However, the effect of expansionary monetary shock during expansion and contraction of the economy is given by Eq. 9. These equations are shown below:

$$\begin{aligned} y_{t+h}= & {} (1 - F(z_{t-1}) \Big (\alpha _{h}^{b} + \beta _{h}^{b} e_{t}^{+} + \gamma ^{b'}y_{t-1}\Big ) \nonumber \\{} & {} + \Big ( F(z_{t-1})\Big ) \Big (\alpha _{h}^{r} + \beta _{h}^{r} e_{t}^{+} + \gamma ^{r'} y_{t-1}\Big ) + u_{t+h} \end{aligned}$$

(8)

$$\begin{aligned} y_{t+h}= & {} (1 - F(z_{t-1}) \Big (\alpha _{h}^{b} + \beta _{h}^{b} e_{t}^{-} + \gamma ^{b'}y_{t-1}\Big ) \nonumber \\{} & {} + \Big ( F(z_{t-1})\Big ) \Big (\alpha _{h}^{r} + \beta _{h}^{r} e_{t}^{-} + \gamma ^{r'} y_{t-1}\Big ) + u_{t+h} \end{aligned}$$

(9)

From these two equations, we have four different cases. The effect of expansionary shock during expansion and contraction, and the effect of contractionary shock during expansion and contraction. Out of these four cases, we only consider two cases: the effect of contractionary monetary shock during expansion and the effect of expansionary shock during contraction. The other two cases such as the effect of contractionary shock during the recession and the effect of expansionary shock during expansion are considered policy mistakes and hence, excluded from analyzing the efficacy of monetary policy.

1.2 7.2 B

See Tables 3, 4, 5 and 6.

See Fig. 14.

Table 3 FEVD with exchange rate model

Table 4 FEVD with asset price model

Table 5 FEVD with interest rate model

Table 6 FEVD with lending rate model

Fig. 14

LPIRFs of three main variables