The IUP Journal of Applied Economics
The Impact of Monetary Policy on Foreign Trade and Investment: A Bayesian VAR Approach

Article Details
Pub. Date : January, 2021
Product Name : The IUP Journal of Applied Economics
Product Type : Article
Product Code : IJAE10421
Author Name : Vijaykumar Dhannur and Ashwin R John
Availability : YES
Subject/Domain : Economics
Download Format : PDF Format
No. of Pages : 14



This paper investigates the impact of monetary policy stance on trade and foreign investment in the pharmaceutical sector in India. It employs the Bayesian Vector Autoregression (BVAR) approach to construct a model and then studies the said impact by the Impulse Response Function (IRF) analysis. In a Bayesian procedure, the parameters are treated as random variables and their posterior distribution is estimated via the imposition of prior beliefs on their distribution, which makes the analysis more robust when combined with Vector Autoregression (VAR). It has been found that both FDI inflows and exports are impacted by inflation and interest rate changes; however, inflationary pressure has a pronounced impact. On the other hand, GDP growth does not seem to substantially impact both FDI inflows and exports as deduced from the Bayesian VAR with Stochastic Volatility and Time Varying Parameters (BVARSV-TVP) model. These findings have been deduced alongside a benchmark VAR model.


Monetary policy stance has, in many empirical studies, shown to have an impact on investments in an industry. The volume of investments also seems to have a considerable impact on the level of exports. In macroeconomics, all the variables have an impact on the other-all are interlinked. A stern monetary policy stance tends to adversely affect investments and subsequently the exports. On the other hand, a growth-oriented monetary policy regime would accelerate investments which, given the multiplier effect, would lead to rapid expansion and thereby increasing export volumes.

This paper studies the impact of monetary policy shocks on the exports and foreign investment inflows from the perspective of the Indian pharmaceutical sector. The call money interest rate (INT) would be acting as a proxy for the monetary policy. In addition to these variables, GDP growth rate (GDP) and inflation rate (CPI) have been included to study their impact on the exports (EXP) and foreign direct investment inflows (FDI). Inclusion of

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