The Cost of Political Intervention in Monetary Policy*

Abstract

AbstractBetween 1994 and 1997, UK monetary policy decisions were taken by the Minister of Finance, but the advice of the central bank was published with a short delay. Thus, the financial markets could observe when the political authority took the same view as the monetary authority and when it did not, and could use evidence of disagreements as prima facie evidence of the pursuit by the political authority of objectives other than the explicit inflation target. This paper finds that the credibility of monetary policy as measured by the long‐term interest differential between the UK and Germany is systematically related to an index of agreement constructed from the agreements or disagreements between the two authorities. No such relationship is found for the yield differential against the US, probably because of the greater prevalence of country‐specific factors, notably inflation scares, over this period in the US. Partial corroboration is found for a subperiod ending in late 1996 from the relationship between the agreement index and the inflation forward rate.