Working Paper: Regime changes in India’s monetary policy and Tenures of RBI governors

Author: Utso Pal Mustafi (CEMFI, Spain) and Rajeswari Sengupta (IGIDR)

Title: Regime changes in India’s monetary policy and Tenures of RBI governors

Abstract: In this paper, we estimate regime switches in Indian monetary policy during the period 1998-2017. Prior to the adoption of an inflation targeting rule in 2016, monetary policy in India was conducted in discretionary manner. The Reserve Bank of India followed a multiple indicator approach in which the policy rate was determined based on a multitude of macroeconomic indicators. Given the absence of any well defined framework, it is possible that monetary policy experienced multiple regime shifts as a consequence of overall macroeconomic developments as well as the discretionary setting of the policy rate by various RBI Governors. We apply a multivariate Markov-switching Vector Autoregression (MS-VAR) model to uncover the time variation in a system of variables related to monetary policy, as reflected through multiple regimes. We find that the optimal number of regimes during this period was three, with one of them being relatively less persistent. Among the other two, one regime corresponds closely to the tenure of Governor Jalan and sporadically appears during the tenure of Governor Reddy whereas the other regime overlaps with the time when Governor Rajan was in office. In contrast, Governor Subbarao’s tenure does not correspond to any specific regime. We also characterise the regimes by the behaviour of specific macroeconomic variables.

Keywords: Markov regime switches, Monetary policy, Inflation targeting, Reserve Bank of India,
Discretionary monetary policy

JEL Code: E4, E5, E6