Mohan i, Debadi ya; Bane jee, Sou ik
A icle
A no e on mone a y policy and long- e m in e es a es in
India: An e icien ma ke s app oach
Jou nal o Applied Economics
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Sugges ed Ci a ion: Mohan i, Debadi ya; Bane jee, Sou ik (2024) : A no e on mone a y policy and
long- e m in e es a es in India: An e icien ma ke s app oach, Jou nal o Applied Economics, ISSN
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A no e on mone a y policy and long- e m in e est a es in
India: an efficien ma ke s app oach
Debadi ya Mohan i & Sou ik Bane jee
To ci e his a icle: Debadi ya Mohan i & Sou ik Bane jee (2024) A no e on mone a y policy
and long- e m in e es a es in India: an efficien ma ke s app oach, Jou nal o Applied
Economics, 27:1, 2385243, DOI: 10.1080/15140326.2024.2385243
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© 2024 The Au ho (s). Published by In o ma
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RESEARCH ARTICLE
A no e on mone a y policy and long- e m in e es a es in
India: an e icien ma ke s app oach
Debadi ya Mohan i
a
and Sou ik Bane jee
b
a
Na ional Ins i u e o Bank Managemen , Pune, India;
b
Managemen De elopmen Ins i u e Mu shidabad,
Mu shidabad, India
ABSTRACT
The p esen s udy aims o empi ically analyze he ela ionship
be ween he g ow h in money supply and he long- e m in e es
a es in India h ough he applica ion o e icien ma ke heo y. The
s udy uses qua e ly da a o e a pe iod om 2010 o 2023. The
ad an age o he e icien ma ke app oach is ha i p o ides a
heo e ical s uc u e o explaining he ela ionship be ween he
money s ock and long- e m a es. F om he e idence, i can be
sugges ed ha he e is no s ong e idence o he iew ha g ow h
in money supply is nega i ely co ela ed wi h changes in long- e m
in e es a es. The implica ions o he s udy depend on he ea -
men o money supply p ocesses in e ms o exogenei y. I he
g ow h in money supply is assumed o be exogenous, hen he
esul o he p esen s udy opposes he commonly held iew ha
an inc ease in he money supply would dec ease he long- e m
in e es a e.
ARTICLE HISTORY
Recei ed 14 No embe 2023
Accep ed 22 July 2024
KEYWORDS
Mone a y policy; money
supply; long- e m in e es
a es; e icien ma ke heo y
1. In oduc ion
Cen al banks, go e ning mone a y policy, a emp o in luence he ela i e p ices
o money a di e en imes and s a es, in o he wo ds, in luencing he sho - e m
and long- e m in e es a es by changing he s ock o money. Al hough achie ing
he op imal a ge s o mone a y policy
1
by adjus ing he money supply g ow h is
ela i ely uncomplica ed, i igno es how he long- e m in e es a es eac o hese
changes in money supply g ow h. This signals why he same le el o mone a y
policy a ge b ings abou di e en economic pe o mances a di e en imes and
in di e en s a es. Long- e m in e es a es play a c ucial ole in de e mining he
le el o economic ac i i y. In ui i ely, he capi al goods essen ial o economic
ac i i ies ca y he p ope y o i e e sibili y and indi isibili y o in es men
pu chase, which poses an op imal s opping cons ain on in es men decisions.
The e o e, i is meaningless o expec ha he mone a y au ho i y can aise
agg ega e demands o capi al goods by me ely changing he sho - e m in e es
CONTACT Debadi ya Mohan i [email p o ec ed] Na ional Ins i u e o Bank Managemen , Pune,
India
1
Gene ally, he sho - e m in e es a es and mainly de e mined h ough he combina ion o he in la ion gap and g oss
domes ic p oduc (GDP) gap (Taylo , 1993).
JOURNAL OF APPLIED ECONOMICS
2024, VOL. 27, NO. 1, 2385243
h ps://doi.o g/10.1080/15140326.2024.2385243
© 2024 The Au ho (s). Published by In o ma UK Limi ed, ading as Taylo & F ancis G oup.
This is an Open Access a icle dis ibu ed unde he e ms o he C ea i e Commons A ibu ion-NonComme cial License (h p://
c ea i ecommons.o g/licenses/by-nc/4.0/), which pe mi s un es ic ed non-comme cial use, dis ibu ion, and ep oduc ion in any medium,
p o ided he o iginal wo k is p ope ly ci ed. The e ms on which his a icle has been published allow he pos ing o he Accep ed
Manusc ip in a eposi o y by he au ho (s) o wi h hei consen .
a e. This is because, in p ac ice, a decline in he sho - e m in e es a e is o en
ollowed by an inc ease in he long- e m in e es a e, discou aging agen s om
in es ing in capi al asse s.
Howe e , a decline in long- e m in e es a es has an expansiona y impac on in es -
men and consume expendi u e h ough i s e ec on he alua ion o capi al, which has
always been he key elemen in he mone a y policy ansmission mechanism. Thus, wi h
an implici belie ha an e ec i e mone a y policy should conside bo h sho - e m and
long- e m in e es a es o boos economic ac i i y, i is essen ial ha he cen al banks
ha e a eliable iew o he ela ionship be ween he changes in he money supply and
in e es a es in he economy.
1.1. Liquidi y e ec , income & p ice le el e ec and p ice an icipa ion e ec
The e ec o g ow h in money supply on he long- e m (nominal) in e es a e has always
been a ho ly deba ed issue in he ield o mone a y economics. Acco ding o he
“Keynesian” s uc u al mac o-models, an inc ease in money supply g ow h leads o
a decline in long- e m in e es a es. This iew is based on he a ionale ha as demand
o money is a dec easing unc ion o nominal in e es a e because o he oppo uni y
cos o holding cash, so an inc ease in he supply o money mus dec ease he in e es
a es o main ain he money ma ke equilib ium e e ed o as he “liquidi y e ec .” The
media has o en epo ed ha he coun y’s go e nmen ad ises he cen al bank no o
decele a e he g ow h in he money supply, as i may lead o an inc ease in in e es a es
o objec ionable le els.
Mil on F iedman (1968, 1969) a gued ha he so-called liquidi y e ec igno es he
dynamic e ec s o he inc ease in he money supply. He p oposed ha inc ease in money
supply has an expansiona y e ec on bo h eal income and p ice le el. This “income and
p ice le el e ec ” hen ends o inc ease he in e es a es h ough he gene al a gumen s
o he money demand unc ion and, he e o e, can coun e he liquidi y e ec . F iedman
u he sugges ed ha an inc ease in money s ock could also in luence an icipa ions o
in la ion. This “p ice an icipa ion e ec ” h ough Fishe (1930) ela ion can e e se he
decline in in e es a es and, a imes, could also o e powe i by showing posi i e
ela ion be ween money supply and in e es a es. Acco ding o he Fishe equa ion,
he nominal in e es a e is equal o he eal in e es a e plus he expec ed a e o
in la ion (Fishe , 1896). I he eal in e es a es a e no a ec ed by mone a y policy,
he Fishe equa ion sugges s ha highe nominal in e es a es a e ela ed o highe
in la ion a es. In he long un, high money supply g ow h a es lead o high in la ion,
and, he e o e, Fishe ’s equa ion implies ha an inc ease in money g ow h a e leads o
an inc ease in nominal in e es a es. This p oposi ion suppo s he causal iew ha
coun ies wi h high g ow h in money supply expe ience a apid inc ease in in e es a es.
Thus, he abo e iews appa en ly o e con lic ing solu ions o he cen al bank’s ques o
ansla e op imal in e es a e a ge s in o money supply g ow h.
1.2. Non-neu ali y o money
In he pas wo decades, he mac oeconomic iews ha e con e ged o o m a heo e ical
consensus e med he new consensus mac oeconomics (NCM) (Ranga ajan & Nachane,
2D. MOHANTI AND S. BANERJEE
2021). One o he iewpoin s o he NCM ene s is ha money is neu al, i.e., i has no
independen impac on he economy excep h ough in e es a es (Wood o d, 2007).
This is e iden om he ac ha in ecen yea s, he money supply is no longe an
explici conce n o mone a y policymake s ac oss he globe, wi h he excep ion o he
Eu opean Cen al Bank. Acco ding o he NCM amewo k, money supply eac s pas-
si ely once he nominal in e es a e is se , adjus ing a a le el de ined by he LM cu e
(Pa a & Kapu , 2010). Fo many yea s, he U.S. Fede al Rese e Boa d has s opped
epo ing money-g ow h a ge s in mone a y policy announcemen s. Al hough he
Eu opean Cen al Bank epo s a de ailed analysis o mone a y and c edi de elopmen s
in Pilla -2, i s only pu pose is o subs an ia e he implica ions o he economic analysis o
Pilla -1. In India, he money supply only ac s as an impo an adjunc o in e es a e
policy, wi h no speci ic a ge s se o mone a y agg ega es. The e o e, i may be said ha
mone a y agg ega es a e now ypically seconda y when de e mining mone a y policy.
Howe e , i would be p ema u e o conclude ha mone a y agg ega es play an
insigni ican ole wi hou e e ence o empi ical da a. Acco ding o Ranga ajan and
Nachane (2021), he NCM model wi h mone a y agg ega es be e explains he empi ical
eali y. They sugges ed ha wi hou he mone a y agg ega es, he NCM model ails o
cap u e he impo an e ec s o money supply on he IS cu e. The neu ali y o money is
based on he assump ion ha he demand and supply o goods and se ices depend only
on ela i e p ices and a e independen o money supply le els. Howe e , s udies like Bils
and Klenow (2004), Balke and Wynne (2007), Anzuini e al. (2012), Pas en e al. (2020),
Mongey (2021) and A ouzi (2023) ha es ed he neu ali y hypo hesis empi ically
demons a e ha mone a y policy shocks do impac ela i e p ices and hence agg ega e
demand. Ano he al e na i e explana ion o he non-neu ali y o money is he mis-
pe cep ion model o Lucas (1972), which holds ha consume s and businesses a e unable
o disc imina e be ween ela i e and agg ega e p ice shocks. Unde his assump ion,
He cowi z (1982) showed ha money supply shocks could esul in a ela i e p ice
dis o ion, whe e some p ices change mo e han o he s bu mo e in he same di ec ion.
Thus, based on he abo e a gumen s, i is possible ha mone a y agg ega es could s ill
ha e some impac on he economy.
1.3. In e es a e channel o mone a y ansmission
The ela ionship be ween money supply and in e es a es can also be in e ed om he
con ex o he in e es a e channel o mone a y ansmission. Typically, mone a y
au ho i ies egula e he mone a y base and/o sho - e m in e es a es. The changes in
he policy a e o sho - e m in e es a es a e ansmi ed h ough he e m s uc u e o
in e es a es o a ec he end-objec i es o in la ion and g ow h. So i he in e es
channel e ec i ely achie es he ul ima e objec i es o p ice s abili y and economic
g ow h, i sugges s ha he mone a y au ho i ies ela i ely succeed in in luencing he
e m s uc u e o in e es a es by egula ing he sho - e m in e es a es ac ions h ough
he liquidi y ope a ions.
Taylo (1995) ound he adi ional in e es a e channel o be an e ec i e channel o
mone a y ansmission based on he inancial ma ke p ices amewo k. Be nanke and
Ge le (1995) a gued ha mone a y policy ins umen s a ec sho - e m in e es a es;
howe e , hei in luence on long- e m in e es a es is negligible, implying he
JOURNAL OF APPLIED ECONOMICS 3
ine ec i eness o in e es a e channels in s imula ing in es men s and pu chasing
du able asse s. Ramey (1993), by inco po a ing he ec o e o co ec ion model
(VECM), showed ha he money channel was highly signi ican compa ed o o he
channels in he US economy. Bean e al. (2002) concluded ha one o he signi ican
easons o he ine ec i eness o in e es a e channels in impac ing he agg ega ed
demand was he p esence o inancial ic ions in he economy. Sme s and Wou e s
(2002) and Angeloni e al. (2003) ound ha he mone a y policy shocks h ough he
in e es a e channel we e he dominan channel in a ec ing consump ion, in es men ,
and eal ou pu in Eu opean coun ies. Ge s enbe ge (2020) obse ed ha he in e es
a e channel emained e ec i e in he pos -c isis pe iod in Ge many, wi h i ms demon-
s a ing esponsi eness o changes in he use cos . Baş a (2020) ound ha he in e es
a e channel is no ope a i e in Tu key in he adi ional o New Keynesian sense.
Ins ead, inc eased demand leads o highe p ices, which subsequen ly in luence in e es
a es, and he e e se also holds ue.
Resul s o empi ical s udies on eme ging and de eloping economies a e simila o
hose o de eloped coun ies. Disya a and Vongsinsi ikul (2003), using he ec o
au o eg essi e (VAR) amewo k, ound ha bo h he in e es a e channel and bank
channel play an impo an in ansmi ing mone a y policy in Thailand. Ama aseka a
(2008) and Kabundi and Ngwenya (2011) concluded ha he in e es a e channel is he
p ima y channel o mone a y ansmission in S i Lanka and Sou h A ica. Kabundi and
Nonhlanhla u he obse ed ha he mone a y policy shocks had a sho - e m e ec on
p ices and agg ega e demand using he ac o augmen ed ec o au o eg essi e (FAVAR)
amewo k. O he s udies like M. S. Mohan y and Tu ne (2008) and Mukhe jee and
Bha acha ya (2011) on eme ging ma ke economies (EMEs) concluded ha he in e es
a e channel a ec s consump ion, in es men , and eal ou pu .
On he o he hand, e iewing some s udies on low-income coun ies disclosed ha he
weak domes ic inancial sys em and segmen ed la ge in o mal sys em impai ed he
e ec i eness o adi ional mone a y ansmission channels (Bha acha ya e al., 2011;
Mish a e al., 2012). In e es ingly, s udies on mone a y policy ansmission in India
depic ed he impo ance o he in e es a e channel. Al-Masha (2003), by applying
a s uc u al ec o e o co ec ion (VECM) model, con i med he impac o in e es a e
channel on key mac oeconomic a iables. The RBI Wo king G oup on Money Supply
(Chai man: Y.V. Reddy, 1998) sugges ed he signi ican p esence o an in e es a e
channel o mone a y ansmission. Rese e Bank o India (2005), inco po a ing he
VAR amewo k, obse ed ha he mone a y igh ening h ough posi i e policy a e
shocks had a nega i e impac on eal ou pu and p ices, and mone a y easing h ough
a posi i e money supply shock impac ed eal ou pu and p ices posi i ely. O he empi i-
cal s udies by Singh and Kali ajan (2007), Pa a and Kapu (2010), and Pandi and
Vashish (2011) depic ed he signi icance o he in e es a e channel o mone a y policy.
Thus, om he li e a u e on mone a y policy ansmission, i can be in e ed ha he e
exis s a gene al consensus on he e icacy o he in e es a e channel o mone a y
ansmission h ough an adjunc o liquidi y managemen .
Li e a u e on he ela ionship be ween g ow h in money supply and long- e m
in e es a es shows bo h lines o empi ical wo k, i.e., a posi i e ela ion e sus an
in e se ela ionship be ween he money s ock and long- e m a es. Al hough
“Keynesian” mac o-econome ic models a e o he iew ha an inc ease in money
4D. MOHANTI AND S. BANERJEE
s ock declines he long- e m a es by imposing a ai amoun o s uc u e in he
es ima ion p ocess, as in Modigliani (1974), hese models igno e he cons ain s
imposed by he e icien ma ke heo y p opounded by Fama (1970). Fu he ,
Mishkin (1981) sugges ed ha mac o-econome ic models can lead o misleading
esul s i inancial ma ke e iciency is no inco po a ed in o hese models. An
al e na i e way is o apply he educed o m es ima ion me hod by eg essing
his o ical changes in long- e m a es on he pas changes in he money s ock,
Gibson (1970). Howe e , he majo challenge wi h his app oach is ha i nei he
imposes any heo e ical amewo k no p o ides any s uc u e o he es ima ion
p ocess. This esul s in a la ge numbe o pa ame e s being es ima ed wi h low
s a is ical powe .
Following he global inancial c isis o 2007–08, pa icula ly a e he implemen a ion
o quan i a i e easing (QE) by he U.S. and a ious o he coun ies, he liquidi y channel
has su aced as a new channel o mone a y policy (see Rodnyansky and Da mouni
(2017), Chak abo y e al. (2020), DiMaggio e al. (2020) and o he s). Quan i a i e easing
(QE) and he subsequen shi in he le el o ese e money ha e gene a ed subs an ial
excess ese es wi hin he banking sys em, he eby os e ing he inclina ion o g an loans
by comme cial banks. Simila beha io by he mone a y au ho i ies was wi nessed du ing
he pos -COVID-19 pe iod when cen al banks wo ldwide adop ed se e al uncon en-
ional mone a y policy measu es o injec liquidi y in o he economy. Following he
oo s eps o majo cen al banks ac oss he globe, he Rese e Bank o India implemen ed
long- e m epo ope a ions (LTRO) and ope a ion wis (OT) o in use liquidi y and
la en he yield cu e o suppo he mo ibund economy (Lakdawala e al., 2023). I has
been obse ed ha du ing excep ional ci cums ances, mone a y base expansion could be
he sole policy ool a ailable o he mone a y au ho i ies. This highligh s he impo an
ole played by he money supply in he economy unde excep ional si ua ions. The e o e,
he p esen s udy a emp s o examine he ole o he money supply du ing he excep-
ionally high liquidi y phase om 2010 o 2023.
Al hough numbe o empi ical s udies ha e been done du ing he pos -c isis pe iod o
unde s and he dynamics o he ansmission mechanism h ough in e es a e channel
(Awdeh e al., 2020; Bhoi e al., 2017; Goyal and Aga wal, 2017; Idd isu & Alagidede,
2020; Kapu and Beh a, 2012; Khund akpam and Jain, 2012; Kohli e al., 2019; D.
Mohan y, 2012; Oyadeyi, 2023), only limi ed li e a u e exis s on he impac o money
s ock on long- e m in e es a es in he con ex o ad anced economies and eme ging and
de eloping economies (some ela ed li e a u e like Amisano & T is ani, 2023; Coch ane,
2024; Deleidi & Le e o, 2021; Lakshmanasamy, 2022; Long e al., 2021; Rasool e al.,
2020and o he s).
In his s udy, an e icien ma ke model ou lined by Mishkin (1981) based on
e icien ma ke heo y has been applied o analyze he ela ionship be ween he
g ow h in money supply and long- e m in e es a es in he con ex o India by
using qua e ly da a o e a pe iod om 2010 o 2023. The ad an age o his
app oach is ha i p o ides a heo e ical s uc u e o explaining he ela ionship
be ween he money s ock and long- e m a es. Fu he , he s udy inco po a es he
“Keynesian” liquidi y p e e ence iew o in e es a e de e mina ion in he e i-
cien ma ke model o be e explain he ela ionship be ween he money s ock
and long- e m a es.
JOURNAL OF APPLIED ECONOMICS 5
Agains his backd op, he p esen pape is o ganized as ollows. Sec ion 2,
desc ibes he amewo k o an e icien ma ke model ha analyses he ela ionship
be ween he g ow h in money supply and long- e m in e es a es. Sec ion 3,
discusses he da a, he es ima ion me hod, and he esul s. Sec ion 4, concludes
he discussion.
2. The amewo k
Acco ding o he e icien ma ke heo y p oposed by Fama (1976), in a capi al ma ke ,
secu i y p ices e lec all he a ailable in o ma ion. In speci ic e ms, i implies ha he
p obabili y dis ibu ion o u u e p ices o secu i ies assessed by he ma ke is equal o he
ue p obabili y dis ibu ion o u u e p ices o secu i ies condi ional o he a ailable
in o ma ion.
Whe e, (P
i,
) = p ice o secu i y i a ime , (ɸ
-1
) = a ailable in o ma ion a ime − 1, E
m
(. . . | ɸ
-1
) = unbiased ma ke expec a ion a − 1and E
m
(. . . | ɸ
-1
) = ue expec a ion
condi ional o ɸ
-1
.
In o de o empi ically apply he abo e concep and o de e mine he equilib ium
p ices, i is impo an o desc ibe he ela ionship be ween cu en p ices and expec ed
u u e p ices. I is a ional o assume ha he ma ke equa es one-pe iod expec ed e u n
ac oss all he secu i ies, conside ing he cons an liquidi y isk p emium. The one-pe iod
e u n o long- e m bonds is gi en in equa ion (x),
Whe e, (*) indica es a andom a iable, (BR*
) = one-pe iod nominal e u n o long-
e m bonds, which includes capi al gain and coupon yield, (P
B
) = p ice o long- e m
bond, and (C
B
) = coupon
Thus, based on he abo e concep s, he ma ke equilib ium model can be p esen ed as,
Whe e, (
-1
) = sho - e m in e es a e and (θ) = cons an liquidi y isk p emium.
Then, he e icien ma ke heo y implies ha ,
As (BR*
-
-1
) in equa ion (4) is unco ela ed wi h any in o ma ion a ailable in he pas ,
equa ion (4) can be ans o med in o a simila e sion o an e icien ma ke model gi en
in equa ion (5),
Whe e, (X
) = explana o y a iables o p icing long- e m bonds, X
e
= E(X
| ɸ
-1
),
op imal expec ed alues condi ional o ɸ
-1
, (λ) = coe icien o explana o y a iables, ε
= e o p ocess wi h no au oco ela ion, i.e., E(ε
| ɸ
-1
) = 0.
Acco ding o Mu h (1961), when expec ed u u e sho - e m a es a e “ a ional” (o
op imally de e mined), he e icien ma ke model shown in equa ion (5) is consis en
wi h he expec a ion heo y o e m s uc u e.
6D. MOHANTI AND S. BANERJEE
The e icien ma ke model emphasizes ha he (BR*
-
-1
- θ) becomes non-ze o only
when a piece o new in o ma ion is a ailable in he ma ke . This sugges s ha in equa ion (5),
only an icipa ed changes in explana o y a iables a e co ela ed wi h (BR*
-
-1
). The
di e ence be ween he an icipa ed and unan icipa ed changes in a iables and i s impac
was empi ically explained by Ba o (1977, 1978). In equa ion (5), i is assumed ha he
coe icien on
-1
is equal o one. This assump ion is based on he p e ious empi ical wo k by
Fama and Schwe (1977) and Mishkin (1981), whe e he gi en ma ke equilib ium model
ailed o ge ejec ed.
As discussed in he in oduc ion, he objec i e o his esea ch is o examine he ela ion-
ship be ween he g ow h in money supply and long e m-in e es a es; he e o e, subs i u ing
g ow h in money supply (MG
) o X
in he e icien ma ke model equa ion (5) gi es,
In India, he money supply is usually measu ed by b oad money (M3) (Dash & Goyal,
2000; Kuma , 2023; Padhan, 2011; Ranga ajan & Nachane, 2021; Sahu & Pandey, 2020).
Howe e , as he e is no po en ial heo e ical eason o es ima ing he model wi h one
mone a y agg ega e, bo h na ow money (M1) and b oad money (M3) a e used o
es ima ing he e icien ma ke model in his s udy. The measu emen o unan icipa ed
g ow h a es o na ow money (M1G) and b oad money (M3G) is explained in he da a
sec ion.
The long- e m in e es a es a e closely and in e sely ela ed o he p ices o he long-
e m bonds, and his indica es ha he e is a high nega i e co ela ion be ween he
change in he long- e m in e es a es and (BR*
-
-1
). Mishkin (1978), in his empi ical
s udy, showed ha his co ela ion was abou −0.96. Thus, as pe he “Keynesian” mac o-
econome ic model, i he unan icipa ed g ow h in he money supply is nega i ely
co ela ed wi h long- e m in e es a es, hen he coe icien (λ
m
) on (MG
- MG
e
),
unan icipa ed g ow h in he money supply should be signi ican ly posi i e, i.e., λ
m
>0.
He e is an impo an ca ea , he e icien ma ke model in equa ion (5) ne e s a es
ha (X
- X
e
) is exogenous, and he e o e he (λ) es ima es a e consis en . A o mal
discussion on he consis ency o (λ) can be ound in Abel and Mishkin (1983). In o he
wo ds, in an e icien ma ke model, a signi ican coe icien (λ) ne e implies causa ion
om unan icipa ed changes in a iables o long- e m bond p ices and, he eby, long-
e m in e es a es. Causa ion could be in he e e se di ec ion o may be non-exis en . I
only shows ha (BR*
-
-1
) co ela es wi h unan icipa ed changes in a iables. The e o e,
one mus be cau ious in in e p e ing (λ) in e ms o causali y.
In he case o he money supply p ocess, i i is exogenous, hen he signi ican (λ)
coe icien suppo s he “Keynesian” iew ha in he sho - un inc ease in he money
supply g ow h would lead o a all in long- e m in e es a es. In li e a u e money supply
p ocess as an exogenous ac o has ecei ed some suppo , Sims (1972). Howe e , i he
money supply p ocess is no exogenous, a iew main ained by many c i ics o mone a is
analysis, Jacobs e al. (1979) and Zellne (1979), he es ima ed (λ) coe icien may be
inconsis en due o he simul aneous equa ion bias and can be misleading in explaining
he impac o g ow h in money supply on long- e m in e es a es.
Acco ding o he neoclassical iew, he money supply g ows h ough he mechanism
which is exogenous o he p essu es o inancial ma ke s, i.e., s ic ly h ough p ocesses
adop ed by he cen al bank. Howe e , Pos Keynesians belie e ha he g ow h in he
JOURNAL OF APPLIED ECONOMICS 7
signi icance le el. The coe icien s (λ
m
) o M1G in panel (B) lead o a simila conclusion
as abo e (equa ion (6) is −0.6204, and equa ion (9) is 0.7353). The coe icien s a e
insigni ican a a 5% signi icance le el and ela i ely small in magni ude e en a e
using esiduals om he mul i a ia e ime-se ies p ocess. One in e es ing obse a ion
Table 2. (Con inued).
Dependen Va iables (X
i
)
M1G M3G IPG (π)
Coe icien s
FTB(−1) 4.75E–07
(0.3602)
1.31E–07
(0.2556)
2.29E–06
(0.1846)
2.72E–07
(0.1540)
FTB(−2) −2.5E–07
(0.7764)
−4.2E–08
(0.6061)
−7.2E–07
(0.5660)
−3.1E–07
(0.2319)
FTB(−3) −2.7E–06**
(0.0329)
−3.6E–07**
(0.0291)
−2.4E–07
(0.7560)
4.06E–08
(0.7640)
FTB(−4) 1.84E–06
(0.1078)
1.23E–07
(0.2892)
6.04E–08
(0.8620)
−3.5E–07
(0.2952)
F-Tes (p alue) 0.1624 0.1186 0.4853 0.3899
R-squa ed 0.7528 0.7970 0.8687 0.8971
S d. E o 0.0265 0.0045 0.0639 0.0104
Du bin-Wa son Tes 1.3616
(0.1497)
1.4855
(0.2489)
1.3996
(0.1172)
1.6284
(0.2796)
(i) Figu es in pa en hesis in he ows o lagged a iables and cons an e m show he p- alue o he - es o H
0
: indi idual
eg ession coe icien s = 0, (ii) Figu es in pa en hesis in he ow o Du bin–Wa son es show he p- alue o H
0
: he
esiduals om an o dina y leas -squa es eg ession a e no au oco ela ed, (iii) Figu es in pa en hesis in ows o
F-s a is ic es show p- alue o null hypo hesis ha he join coe icien s o ou lagged alues a e equal o ze o, and
(i ) ***, **and *deno e 1%, 5% and 10% signi icance le els, espec i ely.
Table 3. Es ima es o e icien ma ke Model using wo-s ep p ocedu e [e icien ma ke models
equa ion (6) (BR*
-
-1
= θ + λ
m
(MG
- MG
e
) + ε
) and equa ion (9) (BR*
-
-1
= θ + λ
m
(MG
- MG
e
) + λ
y
(YG
- YG
e
) + λ
π
(π
- π
e
) + ε
)].
Coe icien s o Dependen a iable: BR*
-
-1
Es ima ion
Models
Eqs (6) & (9)
(M1G -
M1G
e
)
(M3G –
M3G
e
)
(IPG -
IPG
e
) (π - π
e
) R
2
S d.
E o
Du bin-
Wa son Tes
(A) Using esiduals om uni a ia e
models
0.0416
(0.4290)
0.0119 0.0294 2.1017
(0.5898)
0.0528
(0.4534)
−0.1804**
(0.0199)
−0.8891**
(0.0251)
0.2948 0.0253 2.0267
(0.4276)
0.2903
(0.4520)
0.0118 0.0283 2.0127
(0.4975)
0.0664
(0.8673)
−0.1838**
(0.0183)
−0.8655**
(0.0357)
0.2854 0.0254 2.0349
(0.4455)
(B) Using esiduals om
mul i a ia e models
−0.6204
(0.1070)
0.0860 0.0283 2.1939
(0.6946)
0.7353
(0.1885)
−0.0268*
(0.0762)
−5.1690**
(0.0593)
0.1878 0.0272 2.1042
(0.4794)
1.3770
(0.4780)
0.0084 0.0285 2.0054
(0.3785)
1.5149
(0.6400)
−0.1346*
(0.0681)
−3.4362
(0.1242)
0.1698 0.0276 2.1598
(0.5604)
(i) Figu es in pa en hesis o he coe icien s show he p- alue o he - es o H
0
: eg ession coe icien s = 0, (ii) Figu es in
pa en hesis in he ow o Du bin–Wa son es show he p- alue o H
0
: he esiduals om an o dina y leas -squa es
eg ession a e no au oco ela ed, and (iii) ***, **and *deno e 1%, 5% and 10% signi icance le els, espec i ely.
14 D. MOHANTI AND S. BANERJEE
is ha (λ
m
) o M1G in panel (B) o equa ion (6) is nega i e (−0.6204); he de ia ion in
sign could be due o he low R-squa ed alue (0.2438, Table 1) o he uni a ia e model in
de e mining he an icipa ed measu e o M1G. The de ia ion in sign is no seen in (λ
m
) o
M1G in panel (B) o equa ion (9), which is posi i e (0.7353); he eason may be due o he
ela i ely high R-squa ed alue (0.7528, Table 2) o he mul i a ia e model in de e min-
ing he an icipa ed measu e o M1G. Howe e , as he coe icien s a e insigni ican , his
sugges s ha he e is no s ong associa ion be ween he unan icipa ed g ow h in money
supply and he long- e m bond yields. This is also e iden om Figu es 2 and 3, which
show no s ong ela ionship be ween (BR*
-
-1
) and unan icipa ed g ow h in na ow
and b oad money supply based on he esiduals om he uni a ia e and mul i a ia e
models.
The coe icien s o unan icipa ed g ow h in M3 in panels (A) (equa ion (6) is 0.2903
and equa ion (9) is 0.0664) and (B) (equa ion (6) is 1.3770 and equa ion (9) is 1.5149)
show mo e posi i i y; howe e , hese coe icien s a e insigni ican a a 5% signi icance
le el and a e qui e simila using he esiduals o uni a ia e and mul i a ia e ime-se ies
p ocess. This indica es ha he es ima es o unan icipa ed g ow h in b oad money (M3G)
a e no e y sensi i e o he speci ica ion o he ime-se ies p ocesses. The coe icien s o
unan icipa ed g ow h in indus ial p oduc ion and in la ion align wi h he heo e ical
iews. Fo bo h he e icien ma ke models o equa ions (6) and (9), including M1 and
M3, he coe icien s a e nega i e and a e mos ly signi ican a 5% signi icance le el.
-0.05
-0.04
-0.03
-0.02
-0.01
0
0.01
0.02
0.03
-0.4
-0.35
-0.3
-0.25
-0.2
-0.15
-0.1
-0.05
0
0.05
0.1
0.15
Ma -11
Sep-11
Ap -12
Oc -12
May-13
No -13
Jun-14
Dec-14
Jul-15
Feb-16
Aug-16
Ma -17
Sep-17
Ap -18
Oc -18
May-19
Dec-19
Jun-20
Jan-21
Jul-21
Feb-22
Aug-22
BR* - -1 M1G - M1Ge M3G - M3Ge
Figu e 2. Rela ionship be ween (BR*
- -1
), and unan icipa ed g ow h in na ow & b oad money
supply - uni a ia e au o eg essi e app oach. This igu e shows he di e ence be ween qua e ly
nominal e u n o long- e m go e nmen bond and sho - e m in e es a e (BR*
−
-1
) in pe cen age
(le axis), unan icipa ed g ow h in na ow money supply (M1G
– M1G
e
) in pe cen age (le axis) and
unan icipa ed g ow h in na ow money supply (M3G
– M3G
e
) in pe cen age ( igh axis).
Unan icipa ed g ow h in na ow and b oad money supply has been ob ained om he uni a ia e
au o eg essi e ime se ies models.
JOURNAL OF APPLIED ECONOMICS 15
4. Conclusion
The p esen s udy aims o explo e he ela ionship be ween he g ow h in money supply
and long- e m in e es a es. F om he esul s, i can be concluded ha he e is no s ong
e idence o he iew ha g ow h in money supply is nega i ely co ela ed wi h changes
in long- e m in e es a es. The indings o he s udy a e ce ainly o in e es as hey
con adic he con en ional wisdom de i ed om many s uc u al mac o-econome ic
models ha he e exis s a nega i e ela ionship be ween he g ow h in money supply and
long- e m in e es a es. The esul s ein o ce he neu ali y o money ene o new
consensus mac oeconomics (NCM), i.e., money supply has no independen impac on
he economy (I anmanesh & Jalaee, 2021; Issaoui e al., 2015; Kam e al., 2019; Monjazeb
e al., 2020; Pishbaha & Rasouli, 2019). Fu he , he indings o he s udy e eal ha
du ing he sample pe iod o he s udy spanning om he pos -Global Financial C isis
(GFC) e a o he pos -COVID-19 pe iod, cha ac e ized by excep ionally high liquidi y,
he money supply exhibi ed no signi ican ela ionship wi h long- e m in e es a es in
India. This obse a ion sugges s ha despi e subs an ial injec ions o liquidi y in o he
inancial sys em, long- e m in e es a es emained la gely una ec ed by changes in he
money supply o e he long e m. In he pos -COVID-19 pe iod, long- e m in e es a es
in India, pa icula ly go e nmen bond yields, emained ela i ely s able despi e
a signi ican inc ease in money supply. This s abili y can be a ibu ed o se e al ac o s.
Fi s ly, he inc eased go e nmen bo owing o inance pandemic elie measu es exe ed
upwa d p essu e on long- e m yields. Secondly, heigh ened unce ain y abou u u e
economic condi ions made in es o s cau ious, diminishing he ypical impac o an
inc eased money supply on lowe ing long- e m a es. Consequen ly, while he money
supply expe ienced subs an ial g ow h, long- e m in e es a es in India exhibi ed a mo e
-0.008
-0.006
-0.004
-0.002
0
0.002
0.004
0.006
-0.12
-0.1
-0.08
-0.06
-0.04
-0.02
0
0.02
0.04
0.06
Ma -11
Sep-11
Ap -12
Oc -12
May-13
No -13
Jun-14
Dec-14
Jul-15
Feb-16
Aug-16
Ma -17
Sep-17
Ap -18
Oc -18
May-19
Dec-19
Jun-20
Jan-21
Jul-21
Feb-22
Aug-22
BR* - -1 M1G' - M1G'e M3G' - M3G'e
Figu e 3. Rela ionship be ween (BR*
- -1
), and unan icipa ed g ow h in na ow & b oad money
supply – mul i a ia e au o eg essi e app oach. This igu e shows he di e ence be ween qua e ly
nominal e u n o long- e m go e nmen bond and sho - e m in e es a e (BR*
−
-1
) in pe cen age
(le axis), unan icipa ed g ow h in na ow money supply (M1G’
– M1G’
e
) in pe cen age (le axis) and
unan icipa ed g ow h in na ow money supply (M3G’
– M3G’
e
) in pe cen age ( igh axis).
Unan icipa ed g ow h in na ow and b oad money supply has been ob ained om he mul i a ia e
au o eg essi e ime se ies models.
16 D. MOHANTI AND S. BANERJEE
mu ed esponse. This phenomenon e lec s he in ica e in e play o mone a y policy,
iscal p essu es, and in es o sen imen du ing he pandemic.
The limi a ion o he s udy is ha he es ima ion p ocess in ol ed is subjec o
a ia ions along he dimensions like he choice o mone a y agg ega e, he iden i ica ion
o ele an a iables included in he X- ec o , he speci ica ion o he ime-se ies model,
he sample pe iod, and he econome ic echniques. The e o e, one mus be cau ious in
in e p e ing he esul s.
The implica ions o he abo e conclusion depend on he ea men o money
supply p ocesses in e ms o exogenei y. I he g ow h in money supply du ing he
sample pe iod is assumed o be exogenous, i.e., h ough uncondi ional cen al bank
ini ia i es ha a e exogenous o inancial ma ke p essu e, hen he in e p e a ion o
he esul s would be p e y s aigh o wa d, i.e., he esul opposes he commonly
held iew ha an inc ease in he money supply would dec ease he long- e m
in e es a e. This indica es ha he cen al banks canno b ing down he long-
e m in e es a es by inc easing he money supply, a leas in he sho un, and he
mone a y ansmission mechanism based on s uc u al mac o-econome ic models
may equi e some al e a ion. I has been obse ed ha du ing he COVID-19 pe iod,
con en ional mone a y policy ools p o ed inadequa e o s imula ing he eal
economy. Consequen ly, mone a y au ho i ies implemen ed uncon en ional mea-
su es, such as Ope a ion Twis (OT) and Long-Te m Repo Ope a ions (LTRO), o
educe he yield sp ead. Empi ical e idence indica es ha some o hese uncon en-
ional mone a y policy ac ions had a signi ican signaling channel componen ,
whe eby ma ke pa icipan s in e p e ed he announcemen s as indica i e o
a lowe u u e pa h o he sho - e m policy a e. Fu he mo e, i has been obse ed
ha he Rese e Bank o India’s (RBI) o wa d guidance was mo e e ec i e du ing
he pandemic han in he p eceding yea s (Lakdawala e al., 2023). This sugges s
ha uncon en ional mone a y policy in e en ions may be an impo an mechanism
o in luencing long- e m in e es a es when he con en ional money supply chan-
nel has a limi ed e ec on he beha io o he e m p emium.
Howe e , i unan icipa ed g ow h in money supply is no exogenous, i.e., i he
unan icipa ed g ow h in money supply is co ela ed wi h he con empo aneous e o
e m (ε
), hen he es ima es o he e icien ma ke model would be inconsis en and
may lead o misleading in e p e a ions. I can be a case whe e he cen al bank
inc eases he money s ock in eac ion o an unan icipa ed inc ease in long- e m
a es in o de o smoo hen he yield cu e. This esul s in a posi i e co ela ion
be ween he e o e m (ε
) and he unan icipa ed g ow h in money supply (MG
-
MG
e
), and hus, he commonly held iew ha a nega i e ela ionship exis s be ween
he g ow h in money supply and long- e m in e es a es based on many s uc u al
mac o-econome ic models canno be uled ou .
Howe e , i he endogenei y is based on a si ua ion whe e he cen al bank
adjus s he g ow h in money supply wi hin a qua e in esponse o he pas
publically a ailable in o ma ion, hen he e may be no co ela ion be ween he
e o e m (ε
) and he unan icipa ed g ow h in money supply (MG
- MG
e
), and,
he e o e, he endogenei y in he sense o G ange (1969) causali y in he di ec ion
om in e es a e o money g ow h canno indica e he inconsis ency o (λ
m
)
es ima es. Thus, i he commonly held iew is e ained in mone a y economics
JOURNAL OF APPLIED ECONOMICS 17
ha he inc ease in money s ock leads o a dec ease in long- e m a es, hen u he
esea ch is equi ed o e eal a posi i e co ela ion be ween he con empo aneous
e o e m (ε
) and he unan icipa ed g ow h in money supply.
The indings o his s udy ha e signi ican implica ions o unde s anding he impac
o money s ock on long- e m in e es a es in he con ex o India. The s udy applied he
e icien ma ke model, which p o ides a heo e ical amewo k o explaining he
ela ionship be ween money s ock and long- e m in e es a es. The s udy concludes
ha he e is no s ong e idence suppo ing he iew ha g ow h in money supply is
nega i ely co ela ed wi h changes in long- e m in e es a es in India. Consequen ly,
mone a y au ho i ies may need o ely on al e na i e channels o de ise o he uncon en-
ional mechanisms o s ee he eal economy.
Disclosu e s a emen
No po en ial con lic o in e es was epo ed by he au ho (s).
No es on con ibu o s
Debadi ya Mohan i, PhD. is an Assis an P o esso in he Finance a ea a Na ional Ins i u e o
Bank Managemen (NIBM), Pune, India. His p ima y esea ch in e es s a e in he a ea o money
and banking, bank isk managemen and inancial economics.
Sou ik Bane jee, PhD. He is an Assis an P o esso o Finance a Managemen De elopmen
Ins i u e (MDI) Mu shidabad, India. His esea ch in e es s include Co po a e Finance, Co po a e
Go e nance, Beha io al Finance, and Financial Economics.
ORCID
Debadi ya Mohan i h p://o cid.o g/0000-0002-0014-8158
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