Author(s): Subrata Kumar Mitra
Analysis of interest rate determinants involving Taylor rule framework in India suggests that monetary policy appeared more reactive to the inflation gap than to the output gap. Some studies that analyzed interest rate movements in India also advocated the inclusion of other macroeconomic variables in modeling interest rate. In this study, the relationship of interest rate with other macroeconomic latent variables/constructs were examined using partial least squares, where Inflation, Interest rate, Output gap, Foreign trade and Exchange rate were assumed to be independent variables. The use of the partial least square model enabled the inclusion of several indicators to capture latent variable measures and to analyze the influence of these variables on the interest rate.