Asymmetric effects of monetary policy: evidence from India

This paper analyzes the asymmetric effects of monetary policy on the economy. The asymmetric effects of the monetary policy may arise due to the state of the economy, the direction of the shock and the magnitude of the shock. To capture these asymmetric effects, we employed a novel methodology viz nonlinear Local Projections Method. From our analysis for the period from 1996Q(2) to 2020 Q(1), it is observed that there is significant asymmetry in the effects of monetary policy on Indian economy. The asymmetric effects are mainly due to the state of the economy (expansion/recession) and the direction of the shock (expansionary shock/contractionary shock). Further, it is observed that the effects of monetary policy on output are stronger during expansion compared to recession and expansionary shocks have stronger effect on inflation compared to contractionary shocks. When both the sign of the shock and the state of the economy are taken together, it is observed that contractionary shocks during expansion are more effective in affecting the real economy while expansionary shocks during recession significantly affect inflation. Compared to large shocks, small monetary shocks are found to be more effective. We conclude by arguing that the effects of monetary policy are significantly asymmetric and using a symmetric framework may lead to inaccurate and misleading conclusions.