Targeting inflation: Comparative control exercises on models of the UK economy

Abstract

This article presents a comparative control exercise on four leading large-scale models of the UK economy. The target is the reduction of inflation; the policy instrument is the short-term interest rate. Within a standardized experimental design full numerical optimization or feedback control rules are employed as appropriate. An important distinction between models is whether expectations, particularly concerning exchange rate behaviour, are treated in a backward-looking or forward-looking manner. Only the model that adopts the rational expectations hypothesis comes close to satisfying the theoretical proposition that the inflation rate should be changeable without altering any real magnitude.