Is monetary policy safeguarding financial stability in India?

Over the years, there has been an increasing debate over the role of the Central Bank in targeting the policy objectives and the extent to which the targets can anchor the expectations. The present study seeks to identify the linkage between monetary policy and financial stability in India. The study, based on quarterly data from January 2001 to July 2018, finds that the financial sector allied variables (BSE SENSEX index, Exchange Rate and Index of Industrial Production) have shown significant response to shocks in the policy rate, that is, reverse repo rate, except for exchange rate variable that was taken as a proxy for external sector stability. Also in the short‐run, when a shock is imparted to the policy rate, the response of the exchange rate is insignificant. Other than that, the corporate sector along with real output growth and banking sector variables induces a significant change in policy rate when a shock is introduced. With variables responding in the ideal direction to shock in the policy rate, it is inferred that the movement is in line with what ideally should hold over time. This leads us to conclude that the monetary policy safeguards financial stability in India. [ABSTRACT FROM AUTHOR]