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'Correct exchange rate to keep real effective rate stable'

The study, based on macroeconomic variables (such as money supply, wholesale price index and food stocks position), said that the coordination of monetary policy with exchange rate policy was necessary in the liberalised environment while overcorrection of exchange rate was found to be harmful for the economy.

While analysing the monetary impact on inflation, the study observed that the dynamics of inflation in India is adequately explained in terms of monetary factor. The simulation exercise throws up evidence to show that the tempo of price changes dampens over time with a single dose of money supply shock, which implies that inflationary pressure cannot continue in the system indefinitely unless money supply growth is sustained at a higher level.

The study, which made an attempt to track the impact of prices of giving impulses to money supply and effective exchange rate over a period of time, said that the policy adjustments with respect to money supply and real exchange rate depends upon the perception about the level of equilibrium.

In order to attain the equilibrium, policy makers should have a fairly accurate idea about the demands for domestic money supply as well as foreign exchange, it said.

The dynamics of inflation is a matter of intense debate in economics. There are several strands of thoughts explaining inflation dynamics, often with reference to specific countries. The divergence in views of the institutional arrangements and levels of socio-economic development of the countries, give rise to unique structural problems.

But it is important for policy makers to understand the inflation dynamics in the context of their own economics and it is for this reason empirical research into the phenomenon of inflation processes has to be robust and continuous, the study said.

UNI