MONETARY, REAL SHOCKS AND EXCHANGE RATE VARIATIONS IN INDIA

This article examines how a rate of the change of the exchange rate as well as how a rate of the change of the expected exchange rate are related to the unanticipated change in domestic money supply and output. Empirical analysis involves quarterly time series of the rupee/US dollar exchange rate, the narrow money M1, the broad money M3 and output in India under the market based exchange rate regime. The paper testifies exchange rate overshooting phenomenon where both unanticipated M1 and M3 cause variations and depreciation of rupee. Some evidence of the causal role of unanticipated output is observed. The rupee is found to be sensitive with both unanticipated money and output shocks where the impact of money shocks is stronger than output shocks.