Role of Monetary Policy in Exchange Rate Determination: A Case Study of India

Abstract

In this study, we have analysed the effectiveness of monetary policy in affecting the exchange rate primarily under the monetary approach framework. Acknowledging the restrictive assumptions of PPP on which the monetary approach is based we have also incorporated components from the portfolio approach of exchange rate determination in our analysis. We find the monetary policy of India has a limited effect on the changes in the exchange rate. However, this effect remains more or less constant over time. We also infer from our analysis that the portfolio approach is relatively more useful in explaining the exchange rate dynamics of India if not the random walk model.