Effectiveness of Monetary Policy in India: The Interest Rate Pass-Through Channel

The monetary transmission mechanism is the process by which monetary policy actions affect the economy particularly output and inflation. Proper implementation of monetary policy requires an understanding of the instruments and channels through which policy operates. Of the various channels, the interest rate channel has emerged as the dominant channel of transmission of monetary policy. This channel impacts the cost of funds in the economy. When the central bank wants to increase liquidity in the economy it lowers the policy rates which in turn impact market rates, hence lowering the costs of funds and concomitantly stimulating the economy. The stronger the pass-through, the more efficient the transmission mechanism and the easier it would be for the Reserve Bank of India (RBI) to achieve its objectives (Patnaik, 2008).