Macro-economic variables analysis in India: an empirical approach using vector autoregressive model

Abstract

This study investigates the empirical relationship between macro-economic variables such as consumer price index (CPI), gold prices, index of industrial production (IIP), trade balance and crude oil prices – and the direction, magnitude and persistence of their bilateral interactions in the Indian market. Monthly data for all the selected variables were collected over 13 years, from January 2011 to September 2023. Stationarity of all series was first confirmed using the Augmented Dickey-Fuller (ADF) unit root test. The data was analysed using a VAR Model, variance decomposition, impulse response functions, Granger causality tests and Wald lag exclusion tests to identify short-run and long-run relationships among the variables. Results indicate that crude oil prices do not significantly affect CPI at any horizon, suggesting India’s administered fuel pricing insulates domestic inflation from global energy shocks. Crude oil exerts a significant short-run negative impact on gold prices, dissipating in the long run. Contrary to expectation, crude oil significantly Granger-causes trade balance at the 1% level – the strongest result in the study – and is the dominant external driver of IIP variance. CPI significantly and positively Granger-causes both gold prices and trade balance, consistent with the safe-haven hypothesis. Gold prices significantly and negatively affect trade balance, registering the largest VAR coefficient in the system. Trade balance shocks generate sustained long-run negative volatility in gold prices. Notably, IIP is driven exclusively by its own lagged values, remaining unresponsive to all external macroeconomic variables, indicating a self-correcting industrial cycle. The study provides insight to researchers about the behaviour of macroeconomic variables in short and long run and the nature of their interrelationships in an emerging market context. The finding that crude oil is the dominant external driver of both trade balance and IIP variance opens new avenues for research on India’s energy-macroeconomy nexus. This research contributes to the literature by providing original empirical evidence on the short-run and long-run dynamic interactions among five key macroeconomic variables in India over a thirteen-year period, with particular emphasis on the hitherto underexplored role of crude oil as the dominant driver of trade balance and industrial output, and the safe-haven channel linking domestic inflation to gold price dynamics.