Time-variation in response of inflation to monetary policy shocks in India: evidence from TVP-VAR models

This study attempts to explore the time-variation in the response of inflation to monetary policy shocks in India for the period April 1999 to March 2019. In addition to overall response of inflation to policy shocks, we also study the role of three channels: credit, exchange rate and asset prices. This is done in the framework of time-varying parameter VAR (TVP-VAR) with stochastic volatility, which allows the coefficients as well as the covariance matrices in the VAR to evolve over time as random walks. We find substantial time-variation in response of inflation to policy rate. The results suggest that the responsiveness of inflation to policy rate increased in strength till about 2009 but has been declining since then. A study of different channels suggests that this decline has been driven at least in part by decline in the responsiveness of inflation to credit and asset prices, and that of credit and asset prices to the policy rate. The evidence for exchange rate channel is very weak, though it appears to be improving of late.