The Problem: To understand and analyze the mechanisms, effects and consequences of conventional and unconventional monetary policy (UMP) on the Global Financial System and Emerging Markets in particular. The recent financial crisis has changed the mechanism of monetary policy transmission in developed countries. The question that then arises is two-fold. First, has the quantitative easing (QE) policy that has been pursued by central banks affected output, employment and prices? And second, whether QE can continue to stimulate economic activity despite the presence of the zero lower bound and various other financial market frictions. Crockett (2001) notes that it is important to ensure that arrangements for the pursuit of price stability do not inadvertently endanger the stability of the financial system while at the same time the weaknesses of the financial system not impede the effective operation of monetary policy. The overall aim of the research is to then examine whether unconventional monetary policy serves the twin goals of monetary policy – that of price stability on one hand and financial stability on the other.
Methodology: A Vector Auto-Regression (VAR) model was used to build two models. The first model had Federal Funds Rate as a part of the exogenous variables and the second one had Quantitative Easing as a part of the exogenous variables. The research was conducted using longitudinal data from 2008 to 2013 and a quantitative overall design.
Conclusions and Recommendations: The results of the VAR models indicate significant relationships between Indian macroeconomic variables viz. Indian Repo Rate, Inflation and Rupee/Dollar Exchange Rate. Further, the research also displayed long run causality between the variables and short run causality in the currency and interest rate channels. The results of the VAR suggest that Monetary Policy in advanced and emerging economies must consider financial stability and external stability in their mandates.