ENERGY PRICE SHOCKS AND MONETARY POLICY RESPONSE IN INDIA: PRE AND POST INFLATION TARGETING APPROACH

Abstract

This study investigates the dynamic interplay between crude oil price shocks and short- term interest rates in India, emphasizing the effects of inflation targeting (IT) regime implemented in 2016. Considering India’s position as a significant importer of crude oil, it is essential to comprehend the monetary policy reaction to changes in energy prices, particularly regarding developing institutional frameworks. The study utilizes time-series data on monthly-basis spanning from 2011 to 2024 and applies the Autoregressive Distributed Lag (ARDL) model to examine the long-run relationships between crude oil prices and interest rate proxies, such as the 91-day Treasury bill rate and the Call Money rate. Two model specifications are employed to investigate structural changes in policy responsiveness. The first estimate of the relationship uses the full sample and includes an interaction term between crude oil prices and an IT regime dummy to account for shifts occurring after 2016. The second model splits the sample into periods before and after IT, estimating distinct regressions for each. The study indicates that after inflation targeting was adopted, interest rates became significantly less sensitive to shocks in crude oil prices. The pooled model's notable and adverse interaction term indicates a muted policy reaction following the IT, whereas the post-IT model reveals that oil prices have an insignificant effect on interest rates, signifying a structural change in the monetary policy rule. The results indicate that the Reserve Bank of India (RBI) has embraced a framework that is more forward- looking and driven by expectations, with a less aggressive response to temporary supply-side shocks. According to the paper’s conclusion, inflation targeting has played a role in establishing a more stable monetary policy stance in India that emphasizes credibility.