Interest rate pass through in India: Bank Lending Channel

This paper presents the latest evidence for monetary policy transmission in the form of interest rate pass through, from the perspective of the bank lending channel. With the help of the co-integration and error correction mechanism, it has been observed that there is partial pass through to commercial bank lending rates in the Indian Economy. Even the appointment of the Monetary Policy Committee has not yielded any significant results.
Keywords: Monetary Policy, Interest rate transmission, Interest rate pass-through, bank rate, base rate, REPO rate.

The upward and downward movement of the country’s gross domestic product along its long term growth trend is known as business cycle. This conventionally involves two basic types of trends, one of rapid growth, which are called booms, and the other characterised by relatively slow economic growth called recessions. Keeping control over the economy by monitoring and influencing the movements in the business cycle is as essential as it gets. The government can do the same with the help of two tools at its disposal: fiscal and monetary policy. Through the fiscal policy, the government can affect the economy by utilising its taxing and spending powers. And on the other end of the spectrum, it’s the central bank that indulges in creating easy and tight money situations, by using various monetary tools, one example of which is the policy rate. Since both types of policy show results in different time horizons, mostly a combination of both is used by the central authorities to manage output. In the long run, since fiscal policy is observed to have lagged effects, its use goes on. In India, even though fiscal policy has started to explain some major variation in output post the 1991 reforms, but still the effects come with a lag. In the short run though, monetary policy is more effective and hence, widely used.

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