Examining the interest rate channel of monetary policy transmission mechanism in India: An empirical investigation

This paper analyses the effectiveness of the monetary policy transmission mechanism through the interest rate channel using Structural Vector Auto Regressive (SVAR) model and its impact on GDP growth and Inflation in the Indian economy. This study shows that GDP responded negatively to the external shocks like US Fed rate and world oil price shocks while Inflation gives mixed responses and also indicate that the interest rate channel is to some extent is important in monetary policy transmission in India. Further, the present study analyses the impact of US Federal rate (US 3 month treasury rate) on Indian policy rate (Repo rate) by taking US 3 month treasury rate as exogenous as well as endogenous in SVAR models and findings show that there is a negative impact of US Fed rate (US 3 month treasury rate) on Indian policy rate (Repo rate) and short term interest rate (call money rate). This fascinating finding is further supported by using Granger Causality test on these variables and the Granger result shows that US 3 month treasury rate and Repo rate have a causal relationship with each other (same is the case of call money rate). Hence there is a bidirectional causal relationship between US Fed rate (US 3 month treasury rate) and Indian policy rate (repo rate).