impact of monetary policy on indian economy in the post-reform period

savings adversely while making speculative investments more attractive. The most
important contribution <strong>of</strong> the financial system to an economy is its ability to augment
savings and allocate resources more efficiently. A regime <strong>of</strong> rising prices initiates the
atmosphere for promotion <strong>of</strong> savings and allocation <strong>of</strong> investment. While concluding
his article, Rangarajan (1997) (16) suggests that Monetary growth should be so
moderated that while meeting the objective <strong>of</strong> growth it does not push inflation rate
beyond six percent.
What should be the objectives <strong>of</strong> <strong>monetary</strong> <strong>policy</strong>? Can <strong>monetary</strong> <strong>policy</strong> by
itself ensure price stability? What are the respective roles <strong>of</strong> direct and indirect
instruments <strong>of</strong> <strong>monetary</strong> control? Rangarajan (1997) (17) addresses these issues against
the backdrop <strong>of</strong> theoretical developments as well as empirical evidence on the <strong>impact</strong>
<strong>of</strong> <strong>monetary</strong> <strong>policy</strong> in India and elsewhere in the world. As the role <strong>of</strong> <strong>monetary</strong> <strong>policy</strong>
is considered, the stress has been laid on <strong>monetary</strong> management. What the <strong>policy</strong> has
been seeking to do is to modulate money supply growth consistent with expected real
growth. Ensuring price stability requires the pursuit <strong>of</strong> a consistent <strong>policy</strong> over a period
<strong>of</strong> time. This may at times make the central bankers unpopular. The need to take a
view which is not short-term has indeed been one <strong>of</strong> the arguments advanced for
greater autonomy for central banks.
Partha Ray et al. (1998) (18) explores new dimensions in the <strong>monetary</strong>
transmission mechanism in the environment <strong>of</strong> liberalization initiated in the early 1990s
and in the context <strong>of</strong> growing integration <strong>of</strong> financial markets. An examination <strong>of</strong> the
Chakrabarty committee paradigm in this changed milieu is what motivated the author.
The article tries to examine the role <strong>of</strong> two key variables in the conduct <strong>of</strong> <strong>monetary</strong>
<strong>policy</strong>, viz., interest rates and exchange rates. The long-run relationship between
money, prices, output, and exchange rate is examined and the <strong>impact</strong> <strong>of</strong> money market
disequilibrium on interest rate is traced by testing the joint significance <strong>of</strong> the lags <strong>of</strong>
disequilibrium errors. Interest rates and exchange rates are seen to be endogenously
determined in the liberalized regime beginning 1992-93, raising the possibility <strong>of</strong> the
change in transmission mechanism following the advent <strong>of</strong> financial reforms.
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