A Dynamic Monetary Conditions Index for the UK

Abstract

Monetary Conditions Indices (MCIs) are weighted-averages of changes in an interest rate and an exchange rate relative to their values in a base period. A few central banks calculate MCIs for use in monetary policy. Although the Bank of England does not calculate such an index, several international organizations as well as financial corporations construct MCIs for the UK on a regular basis. In this article, we survey those indices and compare their performance. We also suggest an alternative MCI for the UK to be used as a coincident indicator of stance, obtained by estimating and simulating a small-scale macro-econometric model over the period 1984 Q4–1999 Q3. To overcome familiar criticisms of MCIs, our measure innovates upon existing MCIs in several respects. In this sense it may be more informative than those in understanding whether an existing level of interest rates, given the existing level of sterling, makes monetary policy ‘tighter’ or ‘looser’ than in previous periods.