This paper intends to investigate the macroeconomic behaviour of inflation in India through studying the two-way relationship between the exchange rate movements and the adjustments of Cash Reserve Ratio (CRR) in a strict econometric model. Having realized that the effects of the global flow of capital and other shocks are more exposed to India, the research quantifies the co-movements existing in currency volatility and reserve requirement policies on the development of price movements. The investigation splits the short run changes and the long run equilibrium relationship using the autoregressive distributed lag (ARDL) bounds testing methodology to form co-integration between variables. To estimate the dynamic interdependence and transmission channel of policies, a Vector Auto-regression (VAR) model is estimated and the Vector Error Correction Model (VECM) is considered to quantify the speed of correction of a deviation of the long run equilibrium. The analysis of impulse responses and forecast error variance decomposition is also applied to establish the magnitude/persistence of the monetary and exchange rate shocks. The current study can add to the existing empirical literature by providing sufficient empirical evidence on the effectiveness of the liquidity control tools and exchange rate stabilization in dealing with inflation in the context of a developing open economy
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