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The authors would like to thank, without implication, Tamim Bayoumi, Narendra Jadhev, Patricia Reynolds, Christopher Towe, and participants at an Asia and Pacific Department seminar for their comments, and Siddhartha Choudhury, Ioana Hussiada, and Aung Win for research assistance.
While broad money growth was the main policy target, other indicators were also emphasized at different times depending on the prevailing conditions. This may explain the lack of success in meeting the announced monetary target.
Financial deregulation began in earnest in the early 1990s, although important changes in the structure of the financial sector had already started in the 1980s with the growth of the nonbank finance companies (NBFCs). The rapid growth of deposits into these institutions may already have begun to effect the interpretation of the monetary aggregates pre-1990.
Major foodgrains such as rice and wheat and commodities such as sugar and edible oil are partly supplied through the public distribution system (PDS) which runs in parallel with the market system. Supplies for the PDS are purchased from producers at pre-announced procurement prices and are sold to consumers at a subsidized issue price (any individual with a registered residential address is eligible for a ration card that entitles them to buy a fixed quota of goods at the issue price). The Food Corporation of India (FCI) maintains a buffer stock of items sold through the PDS.
However, this does not appear to be true over longer time periods (see Reserve Bank of India, Annual Report, 1996/97, page 64).
Several studies on industrial countries have argued that a non-linear Phillips curve provides a better representation of the data than the linear curve (see Debelle and Laxton (1997)).
Of course, second round effects from the rise in incomes in the agricultural sector may lead to higher demand for manufactured products and a rise in inflation.
On similar lines, De Masi (1997) argues that “the concept of potential output is less meaningful for countries in which a large proportion of output is accounted for by primary commodities whose production is supply determined, or which are experiencing large inflows or outflows of labor.”
While annual data on wages and productivity were published in the Labour Bulletin until the early 1980s, no data current appears to be published. Presumably this is why Balakrishnan’s studies, which were published in the early 1990s, only used data up until 1980.
The Central Statistical organization has recently published quarterly GDP data, but only from 1996 onward.
Given the repressed state of the financial sector in India during the 1980s, interest rates show little movement for much of this period.
The nominal call money rate used in these regressions is probably a poor proxy for the opportunity cost of holding broad money balances given that about 70 percent of broad money is held in interest bearing time deposits. Unfortunately, data on the return on these time deposits is not available to calculate a more realistic opportunity cost.
Most studies of inflation in developing countries find a negative relationship between rainfall and inflation. However, excessive deviations from “normal” rainfall in either direction, ie. droughts or floods will hurt agricultural production and result in higher inflation.
On a larger sample, Jadhev (1994), finds structural breaks in a quarterly money demand function in 1975 and in 1992/83.
Of course, this does not necessarily imply that the output gap model does not work for India. It may be that the Hodrick-Prescott filter does not provide a good characterization of potential output in India.