Money, Prices, and Policy Regimes: Short-Run, Long-Run, and Forecasting Dynamics of Inflation in India (1992–2025)

This paper investigates the dynamic relationship between money supply growth and inflation in India from April 1992 to June 2025, examining both short and long-run relationships, forecasting ability, and structural changes in monetary policy regimes. Using a comprehensive empirical framework that combines Vector Autoregression (VAR), Time-Varying Parameter VAR (TVP-VAR), Vector Error Correction Models (VECM), Granger causality tests and out-of-sample forecasting evaluations using Root Mean Squared Forecast Errors (RMSFE) and Diebold-Mariano tests, the study finds that short-run predictive power of money supply growth is weak and largely unstable for the full sample as well as across regimes. However, a robust long-run cointegrating relationship exists for the full sample, with inflation adjusting to deviations from equilibrium although money supply growth remains largely non-responsive. The regime-specific analysis indicates that the impact of monetary shocks on inflation differs across the Reserve Bank of India’s policy frameworks. This impact is significant during the multiple-indicator approach and is insignificant under the subsequent interest-rate corridor and inflation-targeting regimes. Out-of-sample forecasting results indicate that time-varying VAR models outperform static VAR models when structural shifts occur, highlighting the importance of capturing parameter instability. The findings suggest that money aggregates retain long-run diagnostic value but are unreliable as short-run operational tools for India. Policy implications point to a flexible inflation-targeting approach complemented by medium-term monitoring of money supply deviations.