Financial frictions, bank intermediation and monetary policy transmission in India

Abstract

Do the different types of financial friction have differential implications for monetary transmission in emerging economies? We investigate this question using India as the country for analysis. We adopt a New Keynesian business cycle model with bank intermediation, extend it by the Indian economy-specific features and validate with the data. The baseline model explains the co-movements of interest rates, incomplete pass-through and sluggish adjustment mechanism of the macro-financial variables for a policy interest rate shock. It identifies the collateral-constrained, financially excluded households and low proportion of savers as the primary sources of frictions causing weak monetary transmission.