ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Deconstructing Indian Monetary Policy through the Taylor Rule

It is meaningful to evaluate the Reserve Bank of India's monetary stance through the prism of the Taylor Rule, even if it is inadvisable to apply it mechanically.

These are the personal views of the author.

How does the current policy (repo) rate of 7.25% announced by the Reserve Bank of India (RBI) on 2 June 2015, and left unchanged in its subsequent review of 4 August, stack up, and what could be the central bank’s rationale? The Governor of the RBI. Raghuram Rajan, had to field questions in every fora in June regarding a supposedly hawkish stance on monetary policy that was damaging the recovery. Even the Chief Economic Adviser to the Government of India seemed unsure whether the policy rate was appropriate (Indian Express, 12 June 2015).

If one were to simply go by the Taylor Rule, a commonly used central banking monetary thumb rule for setting benchmark policy rates, the policy rate was consistent with the May 2015 consumer price index (CPI) inflation of 5%, an inflation target of 4%, and an output gap of 0.5%.1 The June CPI inched up slightly higher to 5.4%, vindicating RBI’s hawkish stance on inflation, as the revised policy rate now works out to 7.85% on these parameters.

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