monetary policy and its implication

8/13/2019 Monetary Policy and Its Implication

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Mohit Bansal

07927852

Batch of 2009

Guidance

Prof. Vinish Kathuria

IMPACT OF MONETARY POLICY ON THE ECONOMY:A COMPARISON OF US AND INDIA


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INDEX

1. 42. : .53. ..6

............................64. ..75. ....96. ...107. : .....13

1. 13 ......................................................................................13 ................14 .. ..17

2. ...19 ......20 ...21 ............22 ..............24 ....25 ..26

3. ()27 ...28 .....29

4. .. 30 3 .............................................................................................31


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8. : .....331. & .............342. ......353.

........................35

4. : ....365. 2 ..38

9. : ...391. : .392. () ().40

10. ..4111.....................................4312...44


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The Objective of this project is to understand the various Policy Measures by the Central Banks of bothUS (Fed) and India (RBI). This comes under the light when the Central Banks in different countries are

using the different or sometimes opposite Monetary Policiesat the same time, clearly signifying theirfocus on various issues that are more relevant to their economies.There are instances when RBI (India) isfollowing Contractionary Policy to tackle high Inflation whereas at the same time Fed (US) is followingExpansionary monetary policy with a focus more on GDP growth rate. This project will focus on variousMonetary Tools (like control of interest rate, Reserve ratio and control over Government Bonds in thesystem) with Central Banks and the way they try to take care of various Macroeconomic parameters ofeconomy like Inflation, Unemployment etc in a given time frame. Also Monetary actions take some timeto produce impact on various economic factors because of various lag effects, this project will look intothe lags between various parameters and monetary actions, thus by looking at the output in the form ofchanges in macroeconomic parameters with their monetary tools, this project will highlight how effectivethe monetary policies of various Central Banks are?


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INTRODUCTION: MONETARY POLICY

Monetary policy is the process of controlling the supply of money in the market by the controllingauthority of the country to maintain various parameters.

The controlling authority can be central bank or government of that country, usually it resides in the

hands of Central Bank whereas Government uses Fiscal Policy as a tool to control and maintain certainset of objectives. Both Monetary and Fiscal Policy cannot be seen in isolation, each one is complementaryto another and if one fails to provide solution, other comes in avail to support economy of the country.

Central Banks uses various tools to control Monetary Policy in the country such as changing interestrates, increasing or decreasing reserve ratios and directly going in the markets to buy or sell rupees toalter money supply in the system. The certain objective of Monetary Policy is to attain Price Stability,high employment rate and GDP growth rate. Sometimes in order to control one of the macroeconomicparameter, certain actions are taken which can impact other parameters in a negative way, but this isrequired to take actions to control any parameter which is more sensitive to the economy of that country.


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DECODING MONETARY POLICY: QUANTITY THEORY OF MONEY

Money Supply in the system can be understood by the Quantity theory of Money (given by EconomistHenry Thornton in 1802 and updated by Economist Irving Fisher in 1911) which is related to the numberof rupees exchanged in transactions.

Quantity equation is the money supply (M) times the velocity of money (V) which equals price (P) timestransaction (T)

M x V= P x T

Where

M: Money supplyV: Velocity (frequency) of money changing handsP: Price of GoodsT: No. of Transactions

Now T (Transaction) can be replaced by Y (Real GDP) as total transactions are equal to total GDPproducts produced over given period.

M x V= P x Y

Taking differential on both sides, the above equation will become

d(M) + d(V) = d(P) + d(Y)

Thus change in money supply (M) will directly impact the GDP (Y), inflation (Changes in P) anddetermine the state of economy on the velocity (V).

Eg. With increase in Money supply (M) and keeping the velocity of money constant (V), both Price(P) will increase, thus leading to increase in Inflation and also GDP (Y) will increase.

Example

The equation of exchange can be explained mathematically to explain the direct relation between increasein Money Supply and Inflation.

If Vand Qwere constant, then:


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Thus

Where

(t)Is time.

That is to say that, if Vand Qwere constant, then the inflation rate would exactly equal the growth rate ofthe money supply.

Suppose there is Rs 100 (M) in the system and only economy is producing biscuits, the amount ofBiscuits packets produced 40 units (Y) and the Price of 1 Biscuit packet is Rs 10 (P) , then the no. oftimes money changes hands is 40*10/100 = 4 times (V).

Now in the above economy Say Central Bank increases the Money Supply to Rs.120 and keeping velocity

4 and Production same to 40 units , price will rise to 120*4/40 = Rs. 12/unit.

Thus with increase in Money Supply keeping other things constant, Inflation increases.

Thus Central Bank with its monetary policy determines the amount of money supply in the system,

looking and controlling various other factors in the economy.


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NEED OF MONETARY POLICY

The basic objectives of Monetary Policy to take care of are:

Inflation Unemployment GDP Growth rate

As explained earlier by the Quantity of Money Theory, Inflation and GDP Growth can be altered bychanging Money Supply in the system. Impact of Monetary Policy on Unemployment rate can beunderstood by that with increasing Money Supply in the system, GDP growth will increase which willcome from production of more goods and services eventually creating more labor opportunities in thesystem. Hence with increase in monetary supply in the system, unemployment rate will come down.

The two types of monetary policies adopted by various Central Banks time to time depending upon othereconomic factors are

Contractionary Policy: When the central Bank takes action to reduce supply of money from thesystem, basically increasing the cost of excess money to reduce inflation.

Expansionary policy: When the Central Banks takes action to increase the supply of money in thesystem to ensure easy availability of money at cheaper rates to support high GDP growth and tocombat high unemployment.

Both these types of policies are opposite to each other and steps taken in each of them are exactlyopposite to each other, but each works for the overall development of society and economy depending onrequirement of external factors of Inflation , Unemployment , recession , Booming economy.

Sr. No. Policy Impact on Macroeconomic Variables1 Expansionary Monetary Policy: Increase

Money Supply in the systemInflation

Unemployment Rate

GDP Growth Rate

2 Contractionary Monetary Policy: DecreaseMoney Supply in the system

Inflation

Unemployment Rate

GDP Growth Rate

As we have discussed the impact of both the monetary policies on the various macro policies, the nexttopic will bring out the various tools adopted by various Central Banks to take care of its Monetary Policyand their impact on Monetary Policy. The best thing is to see the impact of each tool on various macro-

economic parameters in togetherness rather than in isolation as all macro-variables is related to eachother. For high inflation and GDP growth rate opposite monetary policies are required and thus impact ofmonetary policy needs to be seen together by analyzing various macroeconomic parameters together.


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TOOLS FOR OPERATING MONETARY POLICY BY CENTRAL BANKS

1. Open Market Operations (OMO)Open market operationsis the way of implementing monetary policy by which a central bank controls

its national money supply by buying and selling government securities, or other financial instruments.OMO has been used constantly to change the size of the monetary base, thereby impacting the totalamount of money circulating in the economy. In OMO, The central bank would buy/sell bonds inexchange for hard currency. When the central bank disburses/collects this hard currency payment, it altersthe amount of currency in the economy, thus altering the monetary base.

2. Interest ratesThe alteration with the Interest Rates has many fold effects on Monetary Policy. Under the normaleconomic environment both the expansionary and Contractionary policy can be controlled by altering theinterest rates, but word of caution always remain as under extreme economic conditions monetary policywith the interest rates too fails to provide the results.. Monetary authorities in different nations have

differing levels of control of economy-wide interest rates. In India ,RBI have different Interest rates bywhich they try to control the Monetary Policy, the increase in any of the Interest rates leads toContractionary Monetary measures whereas with in decrease of these Interest rates , RBI pushed forExpansionary Monetary Policy. The various Interest rates RBI governs to control the Monetary Policy is:

Repo rate/Discount rate: Repo rate is defined at the rate which RBI lends money to other banks inIndia, whenever any Bank needs money it borrows money from RBI at the current Repo Rate, sowith lower Repo rate, banks can get the money at cheaper rates and hence leads to more money atcheaper rates leading to additional supply of money at cheaper rates.

Discount rate is the term used in US for repo rate or base rate.

Implication: With Lower Repo rates, cheaper money will be available hence enhanced money supplybase.

Reverse Repo rate: Reverse Repo rate is defined at the rate which RBI borrows money from otherbanks in India, whenever RBI wants to decrease the money from system , it increases ReverseRepo rate , so that Banks will park their excess Money with RBI and hence will reduce supply ofmoney from the Market. So with higher reverse repo rate, banks will park the money at high ratesand hence leads to reduction in money from the market.

Implication: With higher reverse repo rates, excess money with Banks will be parked with RBI hencereduced money supply base.

3. Reserve requirementsThis comes under regulatory controls over the bank. The reserve is the ratio bank has to maintain withitself of the excess money it holds with itself. Monetary policy can be implemented by changing theproportion of total assets that banks must hold in reserve with the central bank. Banks often hold smallportion of liquid assets in their balance sheets, rest all are invested in various forms of mortgages and


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loans to increase their Net Profit Margins (NPM). By changing the proportion of total assets to be held asliquid cash, the Federal Reserve changes the availability of loanable funds. This acts as a change in themoney supply. Special care is taken of this reserve ratio, as this reserve Ratio has a multiplier effect onlending in the System, so to curb the volatility, this reserve ratio is reviewed on quarterly basis.

Example: If the reserve requirement is 5%, for example, a bank that receives an Rs 100 deposit may lend

out Rs 95 of that deposit. If the borrower then writes a check to someone who deposits the Rs 95, thebank receiving that deposit can lend out Rs 90.25. As the process continues, the banking system canexpand the change in excess reserves of Rs 95 into a maximum of Rs 2000 of money (Rs 100+RS95+90.25+85.73+...=2,000), e.g. Rs 100/0.05=2,000. In contrast, with a 10% reserve requirement, thebanking system would be able to expand the initial Rs. 100 deposit into a maximum of (Rs. 100+90+81+72.25+...=1000), e.g. Rs 100/0.10=1000. Thus, higher reserve requirements reduce artificial moneycreation and thereby reduce money supply in the system.

Cash Reserve Ratio (CRR): CRR defines the ratio of deposit reserves banks has to keep with theRBI. This ratio is of the Net Time and deposit liabilities (NTDL) in India and RBI has theauthority to alter this ratio to change the money left with the banks. With the increase of thisCRR, banks have to deposit more money with RBI and hence they are left with less money,

which can reduce the money in the system.

Implication: With high Reserve ratio, money supply base will contract and hence lead to contractoryMonetary Policy.

Statutory Liquid Ratio: This is again the regulatory measure, under which banks have to keeptheir assets in liquid form. The liquid form can be Cash, Gold or Government Securities. Theprimary objective of SLR is to (1) ensure that banks will remain solvent always (2) keep a checkon expansionary credit policies of the bank. SLR limits has been defined as 40% to 25% (that isbanks SLR can be less than 25% and it should not be more than 40%, defining the band of 25-40%) With increasing SLR, banks are forced to invest in liquid assets and hence less money areavailable for credit expansion for banks, leading to lower money base in the system and hence

contractionary monetary policy is achieved.

RBI has kept the SLR constant for a period of 5 years (25% from April 2003 to November 2008,earlier it used to be above 31% before April 2003); moreover lower limit for SLR is relaxed to24% in November 2008, due to liquidity crisis in market in later half of 2008.

Implication: With low SLR Ratio, credit Expansionary policy by banks can be achieved and hence leadsto expansionary Monetary Policy.


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LAGS IN MONETARY POLICY

There is lag between the Monetary Policy and its impact of economic parameters. Time lags that occur

between the onset of an economic problem and the full impact of the policy intended to correct the

problem. Policy lags come in two broad categories--inside lag (getting the policy activated) and outside

lag (the subsequent impact of the policy). The three specific inside lags are recognition lag, decision lag,and implementation lag. The one specific outside lag is termed impact lag. Policy lags can reduce the

effectiveness of business-cycle stabilization policies and can even destabilize the economy.

Policy lags arise because government actions are not instantaneous. The use of any stabilization policy

encounters time lags between the onset of an economic problem, such as a business-cycle contraction or

the onset of inflation, and the full impact of the policy designed to correct the problem. For example,

should a business-cycle contraction hit the economy on January 1st, stabilization policy cannot correct the

problem by January 2nd. The use of any stabilization policy, especially fiscal policy and monetary policy,

takes time to work through the system.

Policy lags are commonly divided between inside lag and outside lag.

Inside lag is the time it takes between the actual onset of a problem and the launching of the corrective

actions by government. The wheels of government often spin slowly and deliberately. Three types of

inside lag occur.

Recognition Lag:Before any policy action can be pursued, the existence of the actual problemmust be identified. It takes time to collect and analyze economic data. Unemployment andinflation data are usually available only a month or so after the fact. That is, the unemploymentrate for January is usually available in February. Production and income data are reported

quarterly and have an even longer lag. Gross production data for January, February, and March isseldom available until May. Once data are obtained, it must be analyzed and evaluated to ensurethat it reflects the onset of an actual problem, such as a business-cycle contraction. This oftenrequires several months of data to document an actual trend and determine that it is not just atemporary statistical aberration.

Decision Lag:Once government policy makers have identified the problem, they need to decideon a suitable course of action, and then pass whatever legislation, laws, or administrative rules arenecessary. Often this requires an act of Congress, signed into law by the President. Congress isbound to debate the appropriate policy, make amendments, and promote particular politicalinterests along the way. For example, if a business-cycle contraction is identified, Congress islikely to debate over an expansionary fiscal policy use of increased government spending or

decreased taxes. But will the spending go for purchases or transfer payments? If it goes forpurchases, then what types of goods or services are purchased? If taxes are decreased, whichtaxes are cut and who receives the extra income? These decisions could take days, weeks, ormonths.

Implementation Lag:After a particular policy has been selected, steps then need to be taken toimplement the policy. For any change in spending, the appropriate government agencies need to


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be contacted. More often than not, this involves a change in budget appropriations. The affectedagencies then need to actually make changes in their spending. The act of spending is notinstantaneous. Most agencies require competitive bids to identify product suppliers before theycan make the expenditures. Even the employment, then subsequent payment, of additionalworkers takes time. The implementation of fiscal and monetary policy is also likely to take weeksif not months.

Inside lags are likely to take several months. A best case scenario involves at least two months. One

month to recognize the problem and another month to select and implement the appropriation policy. A

more likely scenario is three to six months of inside lags.

The outside lag is the time it takes after a policy is selected and implemented by appropriate government

entities, before it works its magic on the economy. Such magic is not instantaneous. The principal outside

lag is termed the impact lag.

Impact Lag: This lag is the time it takes any change initiated by a government policy to impactthe producers and consumers in the economy. A key part of the impact lag is the multiplier. Aninitial change in government spending, taxes, the money supply, interest rates must work throughthe economy, triggering changes in production and income, which induces changes inconsumption, which causes more changes in production and income, which induces furtherchanges in consumption. Each "round" of changes (consumption expenditures on production thatare induced income) is likely to take a month or two. Several rounds are needed (six to ten ormore) before the bulk of this impact is realized. An impact lag of one to two years is notuncommon.

This project will focus on outside lag with impact lag; it means analysis is done to know how much

lag it takes on macro-economic parameter once the monetary action is taken.


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ANALYSIS: INDIA

Inflation and monetary policy:

They are closely related concepts wherein the latter can be used efficiently to reduce the effect of the

Inflation. Inflation is thought of as the rise in prices and wages that reduces the purchasing power of

money. As a consequence, the purchasing power of money will fall. Most of the countries in the world tryto sustain a lower inflation rates. High inflation lowers the rate of savings and diminishes the purchasing

power. Inflation takes place, when too much money is in circulation in comparison with the production of

goods and services.

Causes of Inflation

The main cause behind inflation is the increase of money supply than the demand for money.

Alternatively, it can be said that when the supply of money per unit of output increases, inflation occurs.

The supply of money per unit of output increases, when "velocity" of money circulation increases. The

demand for money depends on the overall economic activities of a country.

Relationship between Monetary policy and Inflation

The Fisher's equation depicts that proportional relation that exists between money supply and the price

level. Monetary policy is a regulation of a central bank or any regulatory authority that ascertains the size

and growth rate of the money supply. Monetary policy directly influences the interest rates which in turn

has a negative relation with the price level. In the face of inflation the central bank of the country

generally resorts to a rise in the cash reserve ratio, repo rate and reverse repo rate. So the basic idea is to

reduce the money supply in the economy. To this end government securities are also issued so as to mop

up the excess money supply from the mass. This would reduce aggregate demand. This reduction would

again help reduce the price level.


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Inflation and Monetary Tools: Repo Rate and CRR

Repo rate

Repo rate is defined at the rate which RBI lends money to other banks in India. The way in whichchanges in the repo rate affect inflation and the rest of the economy is known as the transmission

mechanism. The transmission mechanism is actually not one but several different mechanisms that

interact. Some of these have a more or less direct impact on inflation while others take longer to have an

effect.

Banks lending rates and interest rates on securities are affected by both the actual and expected repo rate.

If a raise in the repo rate is fully expected, market rates can begin to rise before the repo rate itself is

raised. Then, when the repo rate is actually raised, it will not necessarily have any further effect on market

rates if it merely confirms market expectations.

The following diagram shows the effect of change of Repo rate on Inflation.


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Monetary policy thus has an effect on the interest rates the general public face and thereby also on thetotal demand and total supply in the economy. The channels that mean that market interest rates affectsupply and demand can be divided into the interest rate channel and the credit channel.

Credit channel

The credit channel describes the way in which monetary policy affects demand via banks and otherfinancial institutions. If the interest rate rises, banks choose to decrease their lending and instead buybonds. This means that households and companies find it more difficult to borrow money. Companies thatare either unable or unwilling to borrow must cut back their activities, postpone investment and so on, andthis dampens activity in the economy.

Interest rate channel

The interest rate channel affects the demand for goods and services. Higher interest rates normally lead toa reduction in household consumption. This happens for several reasons. Higher interest rates make itmore attractive to save, in other words to postpone consumption, thus lowering present

consumption. Consumption also falls because existing loans now cost more in terms of interest payments.Finally, higher interest rates mean that the price of both financial and real assets - shares, bonds, property,etc. - falls in that the present value of future returns drops when interest rates rise. When faced withdwindling wealth, households become less willing to consume.

A rise in interest rates also makes it more expensive for firms to finance investment. As a result, higherinterest rates normally curtail investment. If consumption and investment fall, so does aggregate demand.Lower aggregate demand results in lower resource utilization. When resource utilization is low, pricesand wages usually rise at a more modest rate. However, it takes time before a decline in resourceutilization leads to a fall in inflation. This is partly because wages do not change from month to month butmore seldom than that.

Result

Table presents regression of various Time Leads Repo Rate and Inflation.

Data taken in monthly from April 1998- March 2007 for repo rate and inflation

Source: Inflation: RBI database and Repo Rate: Reuters Data base

Variable Coefficients Standard Error t Stat P-value

Intercept 12.53194993 1.391504307 9.006044657 1.50926E-12

0 Months -0.96952424 0.872838383 -1.110771775 0.27133032

1 Months 0.67423314 1.201101166 0.561345838 0.576762217

2 Months 0.020264496 1.206993744 0.016789231 0.986663392


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3 Months -1.277943408 0.998026569 -1.280470328 0.205565965

6 Months -0.015634256 0.710999778 -0.021989115 0.982533435

9 Months 0.734821901 0.634121733 1.158802582 0.251368513

12 Months 0.245546366 0.513404073 0.478271168 0.634286557

18 Months -0.49859229 0.178234872 -2.797389113 0.007013635

Observations

1. This table indicates the lead of Repo rates on Inflation of various time frames. As repo rate andinflation are inversely correlated, negative slope is expected between these two variables.

2. To reject the null hypothesis and to actually say that inflation depends on repo rate, the t valueshould be greater than Critical t-value (which is 1.96 for 95% confidence interval), which isachieved in the lag of 18 months. (indicated by yellow color)

3. The best value of coefficient of regression for this model is 0.518, which is good size of fit.No. of Observations: 66

Value of R2 = 0.518

The equation of Inflation with Repo rate

Inflation = 12.53194993 - 0.49859229 (Repo rate 18 months lead)

All the above observation indicates that maximum effect of repo rates on inflation can be realized with alag of 18 months (indicated by green color)


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CRR and Inflation

Cash Reserve Ratio (CRR) is a % of total deposits of a scheduled bank that has to be mandatorilydeposited by each bank with the Reserve Bank of India (RBI).

If RBI increases the CRR, banks have to deposit an increased proportion of their total deposits to the RBI,which means banks effectively have reduced cash to lend or play around with. On the other hand if theRBI decreases the CRR, banks have more cash at their disposal.

How does it affect inflation? As inflation shoots up with increased demand and reduced supply of goods,If RBI wants to reduce inflation; it has to either reduce demand or increase supply. If the RBI increasesthe CRR, banks have fewer funds to lend, which in effect means borrowing becomes costly, and thatreduces demand. Thus when people go to buy a durable and non durable thing like car, home, automobile,the banks will not be as aggressive to lend the money to buy such goods. Moreover companies have tobook high interests costs on their Profit & Loss statements and this reduces profits. Reduced profitsdepress sentiments and hence demand. A reduction in CRR causes the opposite effect. It increaseddemand.

Result: CRR and Inflation

Analysis is done with CRR and inflation with lag of different months, to find the maximum impact of

CRR on inflation. CRR and inflation are inversely correlated and hence negative slope is expected

between them.

Data taken in monthly from April 1998- March 2007 for CRR and inflation

Source: Inflation: RBI database and CRR: RBI database


Intercept 3.443656 0.529287 6.506217 0.000000

Month 1 2.306883 0.604372 3.816995 0.000259

Months 2 0.010219 0.840071 0.012165 0.990323

Months 3 -0.045148 0.669101 -0.067476 0.946365

Months 6 -0.653625 0.481471 -1.357556 0.178284

Months 9 -1.150174 0.461434 -2.492609 0.014669

Months 12 -0.072556 0.350991 -0.206718 0.836737

Observations


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1. This table indicates the lead of CRR on Inflation of various time frames. As repo rate andinflation are inversely correlated, negative slope is expected between these two variables.

2. To reject the null hypothesis and to actually say that inflation depends on CRR, the t value shouldbe greater than Critical t-value (which is 1.96 for 95% confidence interval), which is achieved inthe lag of 1 month and 9 months. (indicated by yellow color)


Value of R2 = 0.455

The equation of Inflation with CRR

Inflation = 3.4436 +2.3068 (CRR 1 month lead) 1.1501 (CRR 9 months lead)

As there is discrepancy in the relation of CRR (1 m lead) with Inflation as slope being positive between

the two, the relation cannot be established between CRR and Inflation.

Hence from the above analysis, slope is both positive and negative for different lead time of CRR with

Inflation, leads to conclude no relation between CRR and Inflation.


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GDP GROWTH RATE AND MONETARY POLICY

Gross Domestic Product

The gross domestic product (GDP) is one of the measures of national income and output for a given

country's economy. It is the total value of all final goods and services produced in a particular economy;

the dollar value of all goods and services produced within a countrys borders in a given year. GDP canbe defined in three ways, all of which are conceptually identical. First, it is equal to the total expenditures

for all final goods and services produced within the country in a stipulated period of time (usually a 365-

day year). Second, it is equal to the sum of the value added at every stage of production (the intermediate

stages) by all the industries within a country, plus taxes less subsidies on products, in the period. Third, it

is equal to the sum of the income generated by production in the country in the periodthat is,

compensation of employees, taxes on production and imports less subsidies, and gross operating surplus

(or profits)

GDP is broadly categorized into 3 sectors

1) Agriculture2) Manufacturing3) Services

Agriculture:

Agriculture Growth Rate in India GDP had been growing earlier but in the last few years it is constantly

declining. Still, the Growth Rate of Agriculture in India GDP in the share of the country's GDP remains

the biggest economic sector in the country.

Agriculture growth rate in India GDP in spite of its decline in the share of the country's GDP plays a very

important role in the all round economic and social development of the country. The growth rate of the

agriculture sector in India GDP grew after independence for the government of India placed specialemphasis on the sector in its five-year plans. Further the Green revolution took place in India and this

gave a major boost to the agricultural sector for irrigation facilities, provision of agriculture subsidies and

credits, and improved technology. This in turn helped to increase the agriculture growth rate in India

GDP.

The agricultural yield increased in India after independence but in the last few years it has decreased. This

in its turn has declined the Growth Rate of the Agricultural Sector in India GDP. Agriculture Growth Rate

in India GDP declined by 5.2% in 2002- 2003. The growth rate of the agriculture sector in India GDP

grew at the rate of 1.7% each year between 2001- 2002 and 2003- 2004. This shows that agriculture

growth rate in India GDP has grown very slowly in the last few years.

Agriculture growth rate in India GDP has slowed down for the production in this sector has reduced overthe years. The agricultural sector has had low production due to a number of factors such as illiteracy,

insufficient finance, and inadequate marketing of agricultural products. The finance part has been majorly

influenced by repo rate on macro level. Thus this analysis will do whether Repo rate will have any impact

on Agriculture.


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Impact of Repo Rate on GDP Components

Table presents impact of Repo rate on Agriculture growth rate.

Data taken in quarterly from April 1998- March 2007 for repo rate and Agriculture component of GDP

Source: Agriculture GDP: RBI database and Repo Rate: Reuters Data base


Intercept 11.89435842 6.416690383 1.853659395 0.075624902

Lead 2 years 0.039972842 0.606572285 0.065899553 0.947981965

Lead 2 years -1.276556025 0.612830171 -2.083050224 0.047630113

Observation

1. This table indicates the lead of Repo rate on Agriculture (GDP) of various time frames. As reporate and Agriculture growth are inversely correlated, negative slope is expected between thesetwo variables.

2. To reject the null hypothesis and to actually say that Agriculture depends on repo rate, the t valueshould be greater than Critical t-value (which is 1.96 for 95% confidence interval), which isachieved in the lag of 2 lead. (indicated by yellow color)

3. The best value of coefficient of regression for this model is 0.1479, which is not very good size offit.

No. of Observations: 28

Value of R2 = 0.1479

The equation of Agriculture with Repo rate

Agriculture (GDP) = 11.894 1.27655 (Repo rate 2 years lead)

There is considerable lag of 2 years of repo rate on Agriculture growth, primarily because of effects of

repo rate to trickle down to agriculture production with passing of loans to farmers will take time , it

takes time for increase in income of farmers. The low value of regression between 2 indicates other

factors also dominently effects agriculture one could be Monsoons on agriculture.

Manufacutring:

The growth rate of manufacturing sector in a country truly reflects its economic potentiality.

Most of the developed countries are strong enough in their manufacturing sector. Though the services


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sector in India has brought faster economic success, still the manufacturing sector plays an important role

on the ground of sustainability.

In India, though the manufacturing sector is growing at a faster pace still it has failed to some extent with

regards to its percentage share in the total GDP.

The growth rate of manufacturing sector in the country has reached at a two-digit percentage growth in

the year 2006-07 from April-August. India has signifant (39%) manufacturing production from Small and

Medium size industries apart from few big ones. The capital required for Production in all these industries

(even the bigger one) majorly depends upon cost of Capital. Thus theoratically Increase in Repo rate will

increase Cost of Capital and thus reduces the growth rate of Manufacturing.

Table presents impact of Repo rate on manufacturing growth rate

Data taken in quarterly from April 1998- March 2007 for repo rate and Manufacturing component of GDP

Source: Manufacturing GDP: RBI database and Repo Rate: Reuters Data base


Intercept 16.36151897 2.001488257 8.174676475 1.58132E-08

Lead 1 year -1.188718178 0.189201478 -6.282816544 1.42049E-06

Lead 2 years -0.000116676 0.191153432 -0.00061038 0.999517832

Observations

1. This table indicates the lead of Repo rate on Manufacturing (GDP) of various time frames. Asrepo rate and Manufacturing growth are inversely correlated, negative slope is expected betweenthese two variables.

2. To reject the null hypothesis and to actually say that Manufacturing depends on repo rate, the tvalue should be greater than Critical t-value (which is 1.96 for 95% confidence interval), which isachieved in the lag of 1 lead. (indicated by yellow color)



The equation of Manufacturing with Repo rate

Manufacturing (GDP) = 16.3615 1.18871(Repo rate 1 years lead)


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Repo rate has immediate impact on manufacturing, as Capital requirement/availibility at cheaper rate is

the major factor for production in case of manufafturing. With lower Repo rate , easily capital is

availaible and hence manufactuing production increases.

Services

The main thrust to industrial growth has come from the services sector. Services contribute more than 55

per cent of the GDP. Rapidly, the quality and complexity of the type of services being marketed is on the

rise to match worldwide standards. Whether it is financial services, software services or accounting

services, this sector is highly professional and provides a major impetus to the economy . Interestingly,

this sector is populated with a range of players who cater to a niche market.

India is fast becoming a major force in the Information Technology sector. The world's software giants

such as Microsoft, Hughes and Computer Associates who have made substantial investments in India are

increasingly tapping this potential. A number of multi-nationals have leveraged the relative cost

advantage and highly skilled manpower base available in India, and have established shared services and

call centers in India to cater to their worldwide needs.

The software industry was one of the fastest growing sectors in the last decade with a compound annual

growth rate exceeding 50 per cent. Software service exports increased from US$ 4.02 billion in 1999-

2000 to US$ 6.3 billion in 2000-01, thereby registering a growth of 57 per cent. India's success in the

software sector can be largely attributed to the industry's ability to cultivate superior knowledge through

intensive R&D efforts and the expertise in applying the knowledge in commercially viable technologies.

Services growth in India depends on various factors and primarily the boom in seen because of IT/ITES

and Financial services , but again in all free capital plays a major role in the growth of Services .

following is the analysis part to see whether RBI Monetary policy have any impact on Services sector of

India.

Table presents impact of Repo rate on services growth rate

Data taken in quarterly from April 1998- March 2007 for repo rate and services component of GDP

Source: Services GDP: RBI database and Repo Rate: Reuters Data base


Intercept 11.65331194 2.106582989 5.531855141 9.4765E-06

Lead 1 year -0.300298955 0.199136125 -1.508008428 0.144086779

Lead 2 years -0.127701568 0.201190573 -0.634729384 0.531371359

Observation


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1. This table indicates the lead of Repo rate on Services (GDP) of various time frames. As repo rateand Services growth are inversely correlated, negative slope is expected between these twovariables.

2. To reject the null hypothesis and to actually say that Services depends on repo rate, the t valueshould be greater than Critical t-value (which is 1.96 for 95% confidence interval), which is notachieved in any of case.

3. The best value of coefficient of regression for this model is 0.0979, which is not good fit of size.No. of Observations: 28


The equation of services with Repo rate

Services (GDP) no relation with Repo rate is established.

This analysis has shown that Repo rate dont have significant impact on Services (GDP). There could be

many reasons for the same as Major growth un services in depends on IT/ITES which is not effected byRepo rate. Also because of lot of FIIs (in 2007 16 Billion $ compared to less than 2 Billion $ in 2000 )

have played a role of growth of finacial services in india.


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Impact of CRR on GDP

CRR being a reserve ratio changes Money supply in the System Articifically. Increase in CRR will

produce the same effects on major Macro economic parameters as Increae in Repo Rate as increase in

either or both of them reduces the Money Supply from the market , where Increase in CRR indirectly

increase the cost of Capital whereas Repo Rate directly increases the Cost of Capital.With the hike in

CRR , Money Supply from the system reduces (with Multiplier Effect ) and thus reduces the Growth ofGDP Rate . As decrease in CRR and decraese in Repo rate will move in same Monetary policy direction ,

the impact on CRR and repo rate on various GDP components is expected to be same, only possible

variation could be difference in magnitude of impact on GDP components and the different time lag

impact of CRR on various GDP components.

Impact of CRR on GDP Components.

Agriculture

Table Presents impact of CRR on Agriculture production

Data taken in quarterly from April 1998- March 2007 for CRR and Agriculture component of GDP

Source: Agriculture GDP: RBI database and CRR: RBI database


Intercept 5.347775754 3.818963832 1.400321132 0.173706447

Lead 1 year 2.225639715 1.440857625 1.544663176 0.134993359

Lead 2 year -2.347632786 1.17438479 -1.99903201 0.056587123

Observations

1. This table indicates the lead of CRR on Agriculture (GDP) of various time frames. As CRR andAgriculture growth are inversely correlated, negative slope is expected between these twovariables.

2. To reject the null hypothesis and to actually say that Agriculture depends on repo rate, the t valueshould be greater than Critical t-value (which is 1.96 for 95% confidence interval), which is notachieved in any of the case.





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The equation of Agriculture with CRR

Above analysis shows there is not much relation between Agriculture (GDP) and CRR.

Changes in CRR doesnt seem to have impact on Agriculture growth rate.

Manufaturing

Table Presents impact of CRR on manufacturing production

Data taken in quarterly from April 1998- March 2007 for repo rate and Manufacturing component of GDP

Source: Manufacturing GDP: RBI database and CRR: RBI database


Intercept 12.30130465 1.429378046 8.606054001 6.05054E-09

Lead 1 year 0.699426732 0.539290328 1.296939137 0.206494796

Lead 2 year -1.282880944 0.43955374 -2.918598631 0.007336024

Observations

1. This table indicates the lead of CRR on Manufacturing (GDP) of various time frames. As reporate and Manufacturing growth are inversely correlated, negative slope is expected between thesetwo variables.

2.

To reject the null hypothesis and to actually say that Manufacturing depends on CRR, the t valueshould be greater than Critical t-value (which is 1.96 for 95% confidence interval), which isachieved in the lag of 2 lead. (indicated by yellow color)


Value of R2 = 0.444

The equation of Manufacturing with CRR

Manufacturing (GDP) = 12.301 1.2828(CRR rate 2 years lead)

Decrease in CRR increases the money with banks which they can easily lend, as Capital

requirement/availibility at cheaper rate is the major factor for production in case of manufafturing. With

lower CRR , easily capital is availaible and hence manufactuing production increases.


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Services

Table Presents impact of CRR on Services growth

Data taken in quarterly from April 1998- March 2007 for repo rate and Services component of GDP

Source: Services GDP: RBI database and CRR: RBI database


Intercept 13.00604627 0.736884004 17.65005917 1.26081E-15

Lead 1 year 0.277801614 0.278019113 0.999217686 0.327263205

Lead 2 years -0.884859994 0.226602137 -3.904905773 0.000632253

Observations

1. This table indicates the lead of CRR on Services (GDP) of various time frames. As CRR rate andServices growth are inversely correlated, negative slope is expected between these two variables.

2. To reject the null hypothesis and to actually say that Services depends on repo rate, the t valueshould be greater than Critical t-value (which is 1.96 for 95% confidence interval), which isachieved with the lag of 2 years. (Indicated by yellow)

3. The best value of coefficient of regression for this model is 0.6899, which is good fit of size.



The equation of services with CRR

Services (GDP) = 13.00604 0.88485 (CRR lead 2 years)

This analysis has shown that CRR does have impact on Services (GDP).


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()Index of Industrial Production(IIP) in simplest terms is index which details out the growth of varioussectors in an economy. E.g. Indian IIP will focus on sectors like mining, electricity, Manufacturing &General. In case of India the base year has been fixed at 1993-94 hence the same would be equivalent to100 Points

Index of Industrial Production (IIP) is an abstract number, the magnitude of which represents the status ofproduction in the industrial sector for a given period of time as compared to a reference period of time.

The first official attempt to compute and release the Index of Industrial Production was made by Office ofEconomic Advisor, Ministry of Commerce and Industry with the base year 1937 covering 15 importantindustries, which then accounted for more than 90 per cent of the total production of the selectedindustries. As per the United Nations Statistical Organizations recommendation, the general scope of IIPincludes mining, manufacturing, construction, electricity and gas sectors. However, the present generalindex of industrial production compiled in India has mining, manufacturing, and electricity sectors only,due to constraints in data availability on construction and gas sector.

This index indicates the production in industries across various sectors in India and determines the growth

Month by Month on yearly basis. This IIP is directly related to the availability of Capital and thus lower

Cost of Capital will result in higher Industrial Production and hence high growth in IIP.

Cost of Capital is directly related to Repo Rate and CRR. Moreover Impact of Repo Rate and CRR will

take some time to trickle down to produce impact on IIP numbers, so the impact of both Repo Rate and

CRR will come with some lag on IIP numbers.

Impact of Repo Rate on IIP

Table presents impact of repo rate on IIP

Data taken in monthly from April 1998- March 2007 for repo rate and IIP

Source: IIP: RBI database and Repo rate: Reuters database


Intercept 20.22394756 1.948363251 10.37996767 3.71149E-16

Lead1 months -0.578207226 0.292949744 -1.973742042 0.052094585

Lead 2 Months 0.04015633 0.366628596 0.109528637 0.913075745

Lead 3 Months 0.037883498 0.323746127 0.117016066 0.907160113

Lead 6 Months -0.484026663 0.241399651 -2.005084355 0.048562778

Lead 9 Months -0.374437219 0.24065169 -1.555930149 0.123934673


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Lead 12 Months -0.214696992 0.209095798 -1.02678769 0.3078207

Lead 18 Months -0.253797169 0.169906675 -1.493744544 0.139437754

Lead 24 months 0.033277798 0.155478346 0.214034935 0.831100643

Observations

1. This table indicates the lead of Repo rate on IIP of various time frames. As repo rate and IIP areinversely correlated, negative slope is expected between these two variables.

2. To reject the null hypothesis and to actually say that IIP depends on repo rate, the t value shouldbe greater than Critical t-value (which is 1.96 for 95% confidence interval), which is achieved inthe lag of 1 month and 6 months lead. (indicated by yellow color)


Value of R2 = 0. .5032

The equation of IIP with Repo rate

IIP = 20.2239-0.5782 (Repo lead 1 month) -0.484026663 (Repo lead 6 month)

Repo rate has immediate impact on IIP, as Capital requirement/availibility at cheaper rate is the major

factor for production in case of industrial production. With lower Repo rate , easily capital is availaible

and hence manufactuing production increases.

Impact of CRR on IIP

Table presents impact of CRR on IIP

Data taken in monthly from April 1998- March 2007 for CRR and IIP

Source: IIP: RBI database and CRR: RBI database


Intercept 10.76578437 0.982897654 10.95310822 1.00671E-17

Lead1 months 1.896265594 1.117593777 1.696739578 0.093538975

Lead 2 Months 0.392896014 1.57616949 0.249272693 0.803773192


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Lead 3 Months -1.161548601 1.232628709 -0.942334535 0.34878943

Lead 6 Months -0.517118588 0.879751482 -0.587800759 0.558281346

Lead 9 Months -0.85371199 0.858216022 -0.994751867 0.322783361

Lead 12 Months 1.035149786 0.818464109 1.264746707 0.209544855

Lead 18 Months -1.242731003 0.439439363 -2.827991998 0.005885126

Observations

1. This table indicates the lead of CRR on IIP of various time frames. As CRR and IIP are inverselycorrelated, negative slope is expected between these two variables.

2. To reject the null hypothesis and to actually say that IIP depends on CRR, the t value should begreater than Critical t-value (which is 1.96 for 95% confidence interval), which is achieved in the

lag of 18 months lead. (indicated by yellow color)3. The best value of coefficient of regression for this model is 0.4191, which is good size of fitNo. of Observations: 90


The equation of IIP with repo rate

IIP = 10.7657 1.2427(CRR rate 18 months lead)

Decrease in CRR increases the money with banks which they can easily lend, as Capital

requirement/availibility at cheaper rate is the major factor for production in case of industry. With lowerCRR , easily capital is availaible and hence manufactuing production increases.


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MONEY SUPPLY

There are various forms of Money defined depending on the functions of money used as it can be use as

to give loans, keep money in form of Cheques, keeping money in banks, using money through Credit

Cards or simply holding Money in Cash.

Broadly two forms of Money are defined

Narrow Money (M1)

Broad Money (M3)

Before that we also have basic form of Money (M0).

M0:The most liquid form of money and also called Currency in the system both in circulation and in theBank vaults. Also it accounts for the reserves RBI holds of other commercial Banks. M0 is the money

from which other forms of Money M1 and M3 are created with the help of loans and money deposits.

Narrow Money M1:This includes M0+ checkable deposits (sometimes called Demand Deposits); it is

created when the system generates Assets to pay the debt, and thus when loan is sanctioned in the system,

M1 increases in the System. Moreover various forms of Usage of debit cards, Travelers check form a part

of M1.

Broader Money M3: This Includes M1 and Time deposits where Time deposits are mainly saving

accounts.

Symbol Assets included India In USA

C Notes and coins in circulation +

cash with public currency withbanks

Currency

M1 C + demand deposits with banksand other deposits with RBI

C + demand deposits+ Travelerschecks + other checkabledeposits

M2 M1 + Post office savings + Bankdeposits

M1 + Retail Money marketMutual fund balances + Savingdeposits + Small time deposits

M3 M2 + Time deposits M2+ large time deposits+repurchase agreements +Eurodollars + institutional- only

money market mutual fundbalances


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Importance of various Money Supplies in India and US

Symbol India (Rs.Crores)

India (%) USA (billion $) USA (%)

C 483,471 14.5 539 7.4

M1 965,195 28.9 1111 15.2

M2 970,236 29.1 5100 69.6

M3 3,310,278 99.2 7326 100

Thus in india major part of Money is in the form of M3 (99.2 %) whereas both M2 and M3 dominates in

US.

Impact of M3 on GDP

According to the Quantity equation the money supply (M) times the velocity of money (V) which equalsprice (P) times GDP (Y)

M x V= P x Y

M: Money supplyV: Velocity (frequency) of money changing handsP: Price of GoodsY: Real GDP

Taking differential on both sides, the above equation will become

d(M) + d(V) = d(P) + d(Y)

Thus change in Money Supply (M) will directly impact the GDP (Y), keeping inflation and velocityconstant.

Tabular regression between Money supply (M3) and GDP growth rate.

Data taken in annually from Jan 1975 to Jan 2007 for M3 and GDP growth rate

Source: Money Supply M3: RBI database and GDP: RBI database


Intercept 8.528202611 5.018549529 1.699336145 0.10034146

Lead 1 year -0.084176349 0.200381377 -0.420080698 0.677632711

Lead 2 year -0.092236958 0.191610758 -0.481376719 0.633989587


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Observations

1. This table indicates the lead of GDP rate with Money supply M3of various time frames. As GDPrate and Money supply M3 are directly correlated, positive slope is expected between these twovariables.

2. To reject the null hypothesis and to actually say that GDP rate depends on Money supply M3,the t value should be greater than Critical t-value (which is 1.96 for 95% confidence interval),which is not achieved in any of the case.

3. The best value of coefficient of regression for this model is 0.01307, which is not very good sizeof fit.


Value of R2 = 0.01307

The equation of GDP rate with Money supply M3

No relation is achieved between the two.

The above analysis shows the deviation in quatity theory of money, according to which GDP rate should

increase linearly with money supply.


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ANALYSIS OF US MACROPARAMETERS

Discount Rate

The discount rateis an interest rate a central bank charges depository institutions that borrow reservesfrom it. It serves the same function as Repo rate in India. Therefore the monetary policy actions taken by

Fed to use the Discount rate could have significant impact on various macroeconomic parameters.

DISCOUNT RATE & INFLATION

Drawing parallel between the repo rate and discount rate, discount rate should have the same impact on

macroecomomic parameters as the repo rate in case of India has.

Table presents impact of Discount rate on Inflation

Data taken in monthly from April 1998-March 2007 for discount rate and inflation

Source: Inflation: Bureau of Labor Statistics and Discount Rate: Federal Reserve database


Intercept 2.177950303 0.196253749 11.09762392 3.27492E-18

Lead1 months 0.431290127 0.266209997 1.620112439 0.108912465

Lead 2 Months 0.111763737 0.394193788 0.283524857 0.777463955

Lead 3 Months -0.430181043 0.322684383 -1.333132514 0.186050409

Lead 6 Months 0.292888537 0.229330177 1.277147827 0.205027745

Lead 9 Months -0.07813588 0.225576703 -0.346382757 0.729911061

Lead 12 Months -0.041465204 0.197899243 -0.209526846 0.83453835

Lead 18 Months -0.144168011 0.092027223 -1.566580044 0.120928389

Observations

1. This table indicates the lead of Discount Rate with Inflation of various time frames. As discountrate and inflation are inversely correlated, negative slope is expected between these two variables.

2. To reject the null hypothesis and to actually say that Inflation depends on Discount Rate, the tvalue should be greater than Critical t-value (which is 1.96 for 95% confidence interval), which isnot achieved in any of the case.


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3. The best value of coefficient of regression for this model is 0.01307, which is not very good sizeof fit.


Value of R2 = 0.01307

The equation of Discount Rate with Inflation


DISCOUNT RATE AND GDP GROWTH RATE

Table presents the impact of discount rate on GDP

Data taken in quarterly from April 1998- March 2007 for repo rate and GDP growth rate

Source: GDP rate: Bureau of Economic Analysis and Discount Rate: Federal Reserve database


Intercept 3.094944235 0.863116842 3.585776668 0.001175057

Lead 1 year 1.070468163 0.718752288 1.489342269 0.146835991

Lead 2 year -1.108311745 0.715810657 -1.548330882 0.132028496

Observations

1. This table indicates the lead of Discount Rate with GDP growth rate of various time frames. Asdiscount rate and GDP growth rate are inversely correlated, negative slope is expected betweenthese two variables.

2. To reject the null hypothesis and to actually say that GDP growth rate depends on Discount Rate,the t value should be greater than Critical t-value (which is 1.96 for 95% confidence interval),which is not achieved in any of the case.



Value of R2 = 0.074

The equation of Discount Rate with GDP rate



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DISCOUNT RATE AND IIP

Table presents impact of discount rate on IIP

Data taken in monthly from April 1998- March 2007 for discount rate and IIP

Source: IIP: Bureau of Economic Analysis and Discount Rate: Federal Reserve database


Intercept 0.857671956 0.498566509 1.720275912 0.088744329

Lead1 months 3.096285008 0.741018945 4.17841545 6.67505E-05

Lead 2 Months -0.515977169 1.10768731 -0.465814823 0.642448977

Lead 3 Months -0.713700124 0.896775022 -0.79585192 0.428166821

Lead 6 Months -0.819817163 0.625093301 -1.311511676 0.192948573

Lead 9 Months -1.05711363 0.628526992 -1.681890584 0.095981594

Lead 12 Months 0.211253888 0.403835836 0.52311823 0.602149652

Observations

1. This table indicates the lead of Discount rate on IIP of various time frames. As Discount rate andIIP are inversely correlated, negative slope is expected between these two variables.

2. To reject the null hypothesis and to actually say that IIP depends on Discount rate, the t valueshould be greater than Critical t-value (which is 1.96 for 95% confidence interval), which isachieved in the lag of 1 month lead. (indicated by yellow color)

3. The best value of coefficient of regression for this model is 0.6198, which is good size of fitNo. of Observations: 81


The equation of IIP with Discount rate

IIP = 3.09628(discount rate lead 1 month)

This is the exactly opposite what was expected in relation between IIP and Discount rate , instead of

negative slope there is positive slope between the two and with the increase in Discount rate , IIP

increases in US.


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OPEN MARKET OPERATIONS: FED FUND RATE

Open market operations are the means of implementing monetary policy by which a central bank controlsits national money supply by buying and selling government securities, or other financial instruments.Monetary targets, such as interest rates or exchange rates, are used to guide this implementation.

Since most money is now in the form of electronic records, rather than paper records such as banknotes,open market operations are conducted simply by electronically increasing or decreasing ('crediting' or'debiting') the amount of money that a bank has, e.g., in its reserve account at the central bank, inexchange for a bank selling or buying a financial instrument. Newly created money is used by the centralbank to buy in the open market a financial asset, such as government bonds, foreign currency, or gold. Ifthe central bank sells these assets in the open market, the amount of money that the purchasing bank holdsdecreases, effectively destroying money.

The process does not literally require the immediate printing of new currency. A central bank account fora member bank can simply be increased electronically. However this will increase the central bank'srequirement to print currency when the member bank demands banknotes, in exchange for a decrease in

its electronic balance. Often, the percentage of the total money supply consisting of physical banknotes isvery small. In the United States only around 10% of the "M2" money supply actually exists in the form ofphysical banknotes or coins. The rest exists as credits in computerized bank accounts.

In practice, the Federal Reserve uses open market operations to influence short term interest rates, which

is the primary tool of monetary policy. The federal funds rate, for which the Federal Open Markets

Committee announces a target on a regular basis, reflects one of the key rates for interbank lending. Open

market operations change the supply of reserve balances, and the federal funds rate is sensitive to these

operations.[16]In theory, the Federal Reserve has unlimited capacity to influence this rate, and although

the federal funds rate is set by banks borrowing and lending funds to each other, the federal funds rate

generally stays within a limited range above and below the target (as participants are aware of the Fed's

power to influence this rate).

Table presents impact of Fed Fund rate on Inflation

Data taken in monthly from April 1998- March 2007 for Fed Fund rate and Inflation

Source: Inflation: Bureau of Labor Statistics and Fed Fund rate: Federal Reserve database


Intercept 0.052325405 0.03343033 1.565207571 0.121249811

1 month 1.471378031 0.107023547 13.74817099 2.5672E-23

2 Months -0.394991394 0.188960934 -2.090333619 0.039575138

3 Months 0.009986966 0.138242228 0.07224251 0.942578634


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6 Months -0.054355571 0.079069181 -0.687443196 0.493675006

9 months -0.123445287 0.076065598 -1.622879336 0.108318503

12 months 0.089317275 0.056724762 1.574572936 0.119069977

18 months -0.013459582 0.020526884 -0.655705085 0.513784808

Observations

1. This table indicates the lead of Fed funds on Inflation of various time frames. As Fed funds andinflation are inversely correlated, negative slope is expected between these two variables.

2. To reject the null hypothesis and to actually say that inflation depends on Fed Fund, the t valueshould be greater than Critical t-value (which is 1.96 for 95% confidence interval), which isachieved in the lag of 1 month and 2 months lead. (indicated by yellow color)

3. The best value of coefficient of regression for this model is 0.99585 which is good size of fitNo. of Observations: 93

Value of R2 = 0.99585

The equation of IIP with Discount rate

Inflation = 1.471378031 (Fed Fund 1 m lead) -0.394991394 (Fed Fund 2 m lead)

Slope is both positive and negative between the two variables , hence no conclusion can be drawn from it.


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MONEY SUPPLY M2 AND GDP GROWTH RATE

In US prominent Money supply comes in the form of M2 , hence as we have seen earlier according to the

Quantity equation the money supply GDP growth rate should increase with Money Supply M2.

Table presents impact of Money Supply on GDP Growth rate

Data taken in quarterly from Jan 1990- March2007 for money supply M2 and GDP growth rate

Source: GDP: Bureau of Economic Analysis and Money Supply M2: Bureau of Economic Analysis


Intercept 3.833039428 0.591246925 6.482975666 3.05895E-08

Lead 1 year -0.001742694 0.138594785 -0.01257402 0.990014861

Lead 2 years -0.136617509 0.138124865 -0.989087005 0.327114758

Observations

1. This table indicates the lead of GDP rate with Money supply M2of various time frames. As GDPrate and Money supply M2 are directly correlated, positive slope is expected between these twovariables.

2. To reject the null hypothesis and to actually say that GDP rate depends on Money supply M2,the t value should be greater than Critical t-value (which is 1.96 for 95% confidence interval),which is not achieved in any of the case.

3.

The best value of coefficient of regression for this model is 0.0344, which is not very good size offit.



The equation of GDP rate with Money supply M2


The above analysis shows the deviation in quatity theory of money, according to which GDP rate should

increase linearly with money supply.


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COMPARISON BETWEEN MACROECONOMIC PARAMETERS : INDIA AND US

Various Macroeconomic parameters are taken together of India and US and see what is the relation

between the two countries for the same economic paramter. After that if there exits significant relation

between two countries on same parameter, then analysis is done whether the Macroeconomic policy

actions are similar to keep control of that macro-economic factor. Eg . if there exits a similar relation

between Inflation between US and India during the various time frame, then anaylsis is to be seen on the

repo rate (India) and discount rate (US).

Inflation: India and US

Table presents relation between Inflaion of 2 countries

Data taken in monthly from April 1998- March 2007 for Inflation (India and US)

Source: Inflation US: Bureau of Labor Statistics and Inflation India: RBI database


Intercept 1.797514471 0.242580829 7.409960965 2.97158E-11

Inflation India 0.158481425 0.045674798 3.469778341 0.00074958

No of Observation : 110

Significant t- value is found after taking the regression between the inflation of 2 countries and the value

of t is more than the critical t value (1.96 with 95% interval), thus there exists a relation between the two.

Inflation (US) = 1.79751 + 0.1584 (Inflation India)

F test : Inflation: India and US

Variable India Inflation Us Inflation

Mean 5.023482933 2.595462963

Variance 2.878991811 0.724978288

Observations 108 108

Degree of freedom 107 107

F 3.971142112

P(F


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Again the F-test value (3.9711) is greater than critical F value , indiacting Inflation at both the coutries are

similar.

Looking at the similar nature of inflation, now to analyse the monetary actions by 2 countries in the form

of Repo rate and discount rate.

Discount Rate (US) and Repo Rate (India)

Source: Discount rate: Federal Reserve database and Repo Rate: Reuters database


Intercept 3.247976253 0.790269346 4.109961081 7.82195E-05

Repo Rate (India) 0.076488716 0.106590744 0.717592476 0.47458706

No. of observations: 108

Coeffficient of R2: .00483

Significant t- value is not found after taking the regression between the inflation of 2 countries and the

value of t is much less than the critical t value (1.96 with 95% interval), thus there exists no relation

between the two. Also Coeffficient of regression is very low 0.00483.

F-test : Discount Rate (US) and Repo Rate (India)

Variable Discount Rate Repo Rate

Mean 3.800925926 7.229166667

Variance 3.306961751 2.732622664

Observations 108 108

Degree of freedom 107 107

F 1.210178703

P(F


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CONCLUSION

Monetary Policy adopted by RBI and Fed tried to take care of Inflation , GDP Growth rate and

employment. Employment analysis is not done as unemployemnt rate changes in India has been very little

as the variation is .3 in the last one decade , so no conclusion can be drawn on employment rate on the

basis of Monetary policy. Regarding India Moneatry Policy actions are taken in the from of Repo rate

(interest rate) and CRR (reserve ratio) , where in US reserve ratio doesnt play much role , so analysis is

done in the form of Discount rate (interest rate) and Fed Fund rate (OMO).

Analysis have shown that Monetary Policy of India is much stronger than US and Repo rate and CRR do

impact various Macro-economic parameters. The impact of Monetary policy comes with lags of different

time frames on various macro parameters thereby making the job much tougher for centeral banks for

taking Monetary actions.

Following Table concludes relation between various variable and Monetary tools.

Independent

Variable

Dependent

Variable

Expected

Relation

Analyzed

Relation

Lag Equation

India

Repo Rate Inflation Inverse Inverse 18 Months Inflation =12.53194993 -

0.49859229

(Repo rate 18

months lead)Repo Rate Agriculture

GDP

Inverse Inverse 2 years Agriculture(GDP) =

11.8941.27655 (Reporate 2 years

lead)Repo Rate Manufacturing

GDP

Inverse Inverse 1 year Manufacturing(GDP) =

16.36151.18871(Reporate 1 years

lead)Repo Rate Services GDP Inverse No relation - -

CRR Inflation Inverse Discrepancy :Improper

relation

1 month and 9months

Inflation =

3.4436

+2.3068 (CRR

1 month lead)

1.1501 (CRR

9 months lead)


42/44

42

CRR Agriculture

GDP

Inverse No relation - -

CRR Manufacturing

GDP

Inverse Inverse 2 years Manufacturing(GDP) =

12.301 1.2828

(CRR rate 2years lead)

CRR Services GDP Inverse Inverse 2 years Services(GDP) =13.00604 0.88485 (CRRlead 2 years)

Repo Rate IIP Inverse Inverse 1 month and 6

months

IIP = 20.2239-0.5782 (Repo

lead 1 month) -0.484026663(Repo lead 6month)

CRR IIP Inverse Inverse 18 months IIP = 10.76571.2427(CRRrate 18 months

lead)Money Supply

M3

GDP rate Directly No relation - -

US

Discount Rate Inflation Inverse No relation - -

Discount Rate GDP rate Inverse No relation - -

Discount Rate IIP Inverse No relation - -

Fed Fund Rate Inflation Inverse Discrepancy :

Improper

relation

1 month and 2

months

Inflation =

1.471378031(Fed Fund 1 mlead) -0.394991394(Fed Fund 2 mlead)

Money Supply

M2

GDP Growth

rate

Direct No relation - -


43/44


44/44

APPENDIX

India

Inflation : April 1998- March 2009

Repo rate: April 1998- March 2009

CRR : April 1998- March 2009

IIP : April 1998- March 2009

Sector wise GDP Growth rate : April 2000- March 2008

Money Supply M3 : 1975-2008

US

Inflation :April 1998- March 2009

Discount Rate :April 1998- March 2009

Fed Fund Rate : April 1998- March 2009

IIP : April 1998- March 2009GDP Growth rate : Jan 1990- Dec 2008

Money Supply M2 : Jan 1990-Dec 2008

monetary policy and its implication

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