Exploring Performance of Monetary Condition Index (MCI) In Post-Liberalization Period of Indian Economy

The article explores the impact of monetary variables on the aggregate demand side of the economy and thereby the demand pull inflation rate in the post liberalization era of Indian economy. In this article a Monetary Condition Index (MCI) is constructed following a weighted sum approach, in which two pure monetary variables, namely, the short term interest rate and the official exchange rate are incorporated. The MCI is then tested against the inflation rate in the Indian economy. The results generated in this experiments shows that in post liberalization period, the monetary policy variables, short term rate and the exchange rate have not been as useful as one may have been expected them in affecting the aggregate demand side of the economy. This exercise questions the usefulness of MCI as a policy instruments for managing the real economy, specially stabilizing the inflation rate.