NO : WP-2026-018
AUTHOR : Vaibhav Nainwal (CAFRAL), Rajeswari Sengupta (IGIDR) Vidhya Soundararajan (CAFRAL)
TITLE : Inflation Targeting, Monetary Policy Surprises, and Capital Misallocation
ABSTRACT :
We examine whether a more predictable monetary policy framework improves the allocation of capital across firms. Using firm-level data from the Indian manufacturing sector for 2005-2024, we study this in the context of India’s adoption of flexible inflation targeting (FIT) in 2015. We find that firms with high pre-FIT average revenue per unit of capital (ARPK) subsequently accumulate more capital and experience a relative decline in ARPK, consistent with capital being reallocated toward previously under-capitalized firms. Event-study estimates show that these changes emerge after the reform. To further examine the role of monetary policy predictability in capital allocation, we use high-frequency measures of monetary policy surprises. We document a decline in the volatility of these surprises following FIT and show that larger surprises are associated
with higher ARPK and lower capital accumulation, particularly among firms with high ex-ante ARPK. Together, these findings are consistent with greater monetary policy predictability contributing to improved capital allocation following FIT.
Keywords: Flexible inflation targeting; monetary policy; capital misallocation; firm investment; monetary policy surprises.
JEL Code: E22, E52, E58, D24, O16.
Weblink: http://www.igidr.ac.in/pdf/publication/WP-2026-018.pdf
