Academic journal article Researchers World

Is There Any Link between Commodity Price and Monetary Policy? Evidence from India

Academic journal article Researchers World

Is There Any Link between Commodity Price and Monetary Policy? Evidence from India

Article excerpt

ABSTRACT

The aim of this study is to examine the role of the commodity price for predicting GDP, Inflation, Interest rate, and Money Supply in India. This paper attempt to analyze the relationship between commodity prices with GDP, Inflation, Interest rate, and Money Supply. This paper used advanced time series econometric models such as cointegration (Johansen), Vector Error Correction Model (VECM), and granger causality.Empirical evidence indicates that commodity price indices are helpful to predict GDP and Inflation. The findings of this study can be helpful in important implication for monetary authority. Empirical results provide that non-monetary information variables can be useful in predicting some monetary variables.

Keywords: Commodity, Inflation, Interest Rate, GDP, Monetary Policy, Johansen Cointegration, VECM and Granger Causality

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION:

India, a commodity based economy where two-third of the one billion population depends on agricultural commodities, surprisingly has an under developed commodity market. A commodity may be defined as an article, a product or material that is bought and sold. It can be classified as every kind of movable property, except Actionable Claims, Money & Securities. Commodity market is an important constituent of the financial markets of any country. It is the market where a wide range of products, viz., precious metals, base metals, crude oil, energy and softcommodities like palm oil, coffee etc. are traded. It is important to develop a vibrant, active and liquid commodity market. Consequently four commodity exchanges have been approved to commence business in this regard. They are (1) Multi Commodity Exchange (MCX) located at Mumbai. (2) National Commodity and Derivatives Exchange Ltd (NCDEX) located at Mumbai. (3) National Board of Trade (NBOT) located at Indore. (4) National Multi Commodity Exchange (NMCE) located at Ahmedabad.

Increases in the quantity of money or in the overall money supply (or debasement of the means of exchange) have occurred in many different societies throughout history, changing with different forms of money used. An increase in the general level of prices implies a decrease in the purchasing power of the currency. That is, when the general level of prices rises, each monetary unit buys fewer goods and services. The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden costs to some and benefits to others from this decrease in the purchasing power of money. For example, with inflation, lenders or depositors who are paid a fixed rate of interest on loans or deposits will lose purchasing power from their interest earnings, while their borrowers benefit. Individuals or institutions with cash assets will experience a decline in the purchasing power of their holdings. Increases in payments to workers and pensioners often lag behind inflation, especially for those with fixed payments.

Kimberly Amadeo (US Economy Guide):Monetary policy is what central banks use to manage the amount of liquidity in the economy. Liquidity is the total amount of money, including cash, credit and money market mutual funds. The important part of liquidity is credit, which includes loans, bonds, mortgages, and other agreements to repay.

REVIEW OF THE LITERATURE:

(Garner, 1985) analysis of the advantages and disadvantages of using commodity prices as target variable suggest that commodity prices are not a feasible policy target, as they cannot be adequately controlled by the central bank, rather, at best, it can be used as one of several information variables in designing and conducting monetary policy. Garner's (1989) research concludes the same, that is, controlling commodity price index will not guarantee stable price level, as they are not cointegrated. (Frankel J. A., 1986) has contributed a kind of overshooting theory of commodity prices. …

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