Operationalising Taylor-type Rules for the Indian Economy: Issues and Some Results (1992Q3 2001Q4)

This study is an attempt to formulate a monetary policy reaction function for India. In particular I model backward and forward looking Taylor and McCallum rules for the period post BoP crisis. It is found that backward-looking McCallum rule tracks the evolution of monetary base over the sample period reasonably well, suggesting that RBI acts as if it is targeting nominal income when conducting monetary policy. Recent declaration by the RBI that reserve money is its operating target (Annual Reports, 2001-02 and 2002-03) lends support to the findings of the study.

A Re-look at the Long-Run Stability of the Money Multiplier in India

Results on long-run stability of M1 and M3 money multipliers in India are presented after the BoP crisis. Allowing for in-sample regime switching it is found that M3 money multiplier can be characterized by a one-time regime shift around the beginning of 1997, the time when money markets reform first begun in a big way, with issuance of ad hoc 14-day on tap T-Bills giving way to Ways and Means Advances. Results on the stability of M1 multiplier are less clear and relationship, if it exists, is statistically weak. Although evidence from CUSUM-SQ tests and recent (more powerful) unit root tests suggests that M1 and adjusted monetary base are cointegrated.

Fan Charts as Useful ‘Maps’ for an Inflation-Targeting Central Bank: An Illustration of the Sveriges Riksbank’s Method for Presenting Density Forecasts of Inflation

In this study I illustrate the usefulness of Fan Charts for a central bank and show how they can be used to present its viewpoint on likely paths of future inflation. Exploiting a bivariate unobserved components model, I use the methodology followed by Blix and Sellin (1998) to demonstrate how subjective judgements can be systematically incorporated into model-based forecasts and effectively presented in a graphic manner.

Estimating Output Gap for the Indian Economy: Comparing Results from Unobserved-Components Models and the Hodrick-Prescott Filter

Output gap estimates are constructed for India using unobserved components model (UCM) approach on the lines of Watson (1986) and Kuttner (1994). Results from UCMs are not found to be any less sensitive to data revisions when compared to those from the Hodrick-Prescott filter. This, however, could be because of lack of sufficient ‘revised-data’ on which the sensitivity of the results can be tested. Based on standard deviation of change in potential output to data revisions and its ‘economic’ content, the UCM using trimmed mean as the numeraire for inflation comes forth as the best choice. Alternative estimates of “core” inflation, included as a state variable in one of the UCMs, are also provided

Unit Root Tests: Results from some recent tests applied to select Indian macroeconomic variables

Results from newly developed unit roots tests of ERS (1996), PN (1996), NP (2001) and LM (1994) are compared against their traditional counterparts (ADF, PP and KPSS) on select Indian macroeconomic data. Results from ERS, PN and NP are broadly in agreement. However, using the general to specific criterion of Hall (1994) and the Modified Information Criterion (MIC) of NP for lag length selection, it is found that different lag length can lead to different results. Furthermore, results from using these criteria are also sensitive to the maximum lag length. Both KPSS and its modified version, LM, are found to be prohibitively sensitive to the lag length used. Since as of now no theoretical criterion exists for lag length selection for tests which test the null of stationarity, their use should be avoided, even for the purpose of so-called ‘confirmation’. Another important finding is that frequency of the data and span covered by the sample size plays an important role and whenever feasible, tests must be conducted with as many different frequencies as the availability of data permits. It is not only a large sample size that is important, but also the span covered, an issue raised long ago by Campbell and Perron (1991).

Distribution of Cross-Section of Price Changes and Measurement of Inflation

In this study we look at the statistical properties of components forming the Wholesale Price Index (WPI), the headline inflation index for the Indian economy. We find that not only is the distribution of price changes at the disaggregate level highly leptokurtic, but also the cross-sectional distribution of price changes is positively skewed. This has the implication that the weighted mean would fail to be an efficient estimator of inflation. Trimmed Means, belonging to the class of limited influence estimators, have been used by many central banks to get around the skewness problem. We also explore the use of trimmed means for efficiently estimating inflation for India. In particular, we study the robustness of trimmed means to the benchmark (Centered Moving Average vs. trends derived from the Hodrick Prescott Filter) and the evaluation criteria (Mean Absolute Deviation vs. Root Mean Square Error vs. an Asymmetric Loss Function). Although we study the performance of trimmed means against the weighted mean in some detail, we stop short of proposing any ‘one’ trimming pattern as the ideal. The selection of the headline inflation rate depends as much on its ability to track the underlying trend void of transitory disturbances as much on its ability to forecast future inflation and its correlation with money growth, something we don’t deal with in the present study.