The Contribution of Food Subsidy Policy to Monetary Policy
Résumé
Monetary policy is generally viewed in the literature as the only institution responsible for price stability. This approach overlooks the importance of food price stabilization policies, which are particularly important in low- and middle-income economies. We estimate a Bayesian DSGE model that incorporates monetary and fiscal policy tailored to India, where the latter includes a food demand and subsidy framework replicating the central issue price (CIP) and minimum support prices (MSP) policy framework, respectively. We find that following a world food price shock, CPI and therefore interest rate volatility would be 24% higher absent food subsidies. Putting this effect aside would lead to overestimate the effectiveness of inflation targeting in EMEs. A main finding is the subsidy policy has large heterogeneous distributional effects: welfare is increasing (decreasing) the higher intensity of food demand intervention for the non-Ricardian (Ricardian) household.
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