UK Monetary Policy Research Articles

Monetary policy shocks and financially constrained stock returns: The effects of the financial crisis

This study provides comprehensive evidence on the return response of financially constrained firms listed on London Stock Exchange (LSE) to UK monetary policy shocks extracted from the Bank of England's MPC meetings relative to expectations embedded in interest rate futures prices, during the period June 1999–December 2011. Using a large number of financial constraints proxies, we find no significant evidence that the most constrained firms' returns are more responsive to monetary policy shocks relative to the least constrained ones, as the credit channel of the monetary policy transmission mechanism would suggest. We also show that the inverse relationship between interest rate shocks and UK stock returns reversed its sign and became significantly positive during the recent financial crisis period. Our results show that the Bank of England can affect stock market valuations by modifying interest rates, but this impact is much stronger during periods of tight credit market conditions. Hence, apart from the credit conditions in the wider economy, central banks should also monitor the response of capital and money markets' participants to their policy decisions.

The Distributional Impact of Monetary Policy Easing in the UK between 2008 and 2014

Monetary policy has the potential to affect income and wealth inequality in the short run. This has always been true, but given the unprecedented period of accommodative policy in a number of advanced economies including the UK over the past decade, it has become more important to understand the size and direction of these effects. We use panel data from the ONS Wealth and Assets Survey on households’ characteristics and balance sheet positions to estimate the distributional impacts of UK monetary policy between 2008 and 2014. Our results suggest that the overall effect of monetary policy on standard relative measures of income and wealth inequality has been small. Given the pre-existing disparities in income and wealth, we estimate that the impact on each household varied substantially across the income and wealth distributions in cash terms, but in percentage terms the effects were broadly similar. We estimate that households around retirement age gained the most from the support to wealth, but that support to incomes disproportionately benefited the young. Overall, our results illustrate the importance of taking a broad-based approach to studying the distributional impacts of monetary policy and of considering channels jointly rather than in isolation.

International Spillovers of Monetary Policy: Evidence from France and Italy

In this paper we provide empirical evidence on the impact of US and UK monetary policy changes on credit supply of banks operating in Italy and France over the period 2000-2015, exploring the existence of an international bank lending channel. Exploiting bank balance sheet heterogeneity, we find that monetary policy tightening abroad leads to a reduction of credit supply at home, in particular for US monetary policy changes. Our results show that USD funding plays an important role in the transmission mechanism, especially for French banks which rely to a larger extent on USD funding. We also show that banks adjust their euro and foreign currency lending differently, thus implying that funding sources in different currencies are not perfect substitutes. This is especially the case when tensions in currency swap markets are high, thus resulting in costly cross-currency funding.

International Spillovers of Monetary Policy: Evidence from France and Italy

In this paper we provide empirical evidence on the impact of US and UK monetary policy changes on credit supply of banks operating in Italy and France over the period 2000–2015, exploring the existence of an international bank lending channel based on the reliance on funding sources located in these two countries or denominated in their currency. We find that US monetary policy tightening leads to a reduction of lending to the domestic economy in both France and Italy, and this is mainly driven by banks that relied more intensely on USD funding markets. Conversely, we find that both French and Italian banks are isolated from UK monetary policy shocks, as most of their UK funding is denominated in Euro, despite being larger than funding from the US. JEL Classification: E51, F30, F42, G20

Constitutions as communication

A neglected function of constitutions is their role in facilitating communication. This is particularly important if one accepts the approach of constitutional pluralism, both at the international level and between plural constitutions at the national level. Communication may be between different types of constitutions or between legal and other forms of social systems such as the economy and politics. Theoretical support for this approach can be found in Habermas’s discursive theory of democracy, and also in recent developments in systems theory. The role of constitutional communication is here illustrated through four case studies drawn from economic management. The first two concern failures of communication through the use of balanced budget rules, and in the breakdown of institutional relations in the UK under the pressure of the financial crisis of 2008–2009. The other two identify successes; the German Federal Constitutional Court’s support for legislative deliberation in relation to eurozone rescue measures and the development of countervailing institutions linked by soft law in UK monetary and fiscal policy.

Unwinding: A Tale of Corridors and Floors

I discuss six tools available to monetary policy makers. Three of these have been used since the inception of central banking. Three are new and were introduced in the aftermath of the 2008 financial crisis. I argue that, when the UK Monetary Policy Committee raises the interest rate, it should maintain a large balance sheet that consists of both risky and safe assets. Further, the Bank should trade the risk composition of its balance sheet to promote the stability of asset prices.

Asset prices regime-switching and the role of inflation targeting monetary policy

This paper provides the empirical framework to assess whether UK monetary policy shocks induce both the UK housing market and the UK stock market to remain at a high-volatility (risk) environment. The Markov regime switching modelling approach is employed in order to identify two distinct environments for each market, namely, a high-risk environment and a low-risk environment, while a probit model is employed in order to test whether monetary policy shocks provide this predictive information regarding the current state of both markets under consideration. Our findings indicate that monetary policy shocks do indeed have predictive power on the stock market. In addition, in both asset markets, there is a key role for inflation. Results are important especially within the framework of the inflation targeting monetary policy regime.

UK Monetary Policy from Devaluation to Thatcher, 1967–82, by Duncan Needham

UK Monetary Policy from Devaluation to Thatcher, 1967–82, by Duncan Needham

Model-free jump measures and interest rates: common patterns in US and UK monetary policy around major economic events

We employ model-free jump measures to study monetary policy operations in the UK and USA around major economic events by exploiting the relationship between jumps, interest rates, and macroeconomic news releases related to monetary policy. In our analysis, we explicitly account for the timing of jumps in UK and US interest rates and the correlation across jumps in the same two interest rates and whether these match Federal Open Market Committee (FOMC)/Monetary Policy Committee news releases. We find that FOMC news releases lag jumps in US interest rates, but lead jumps in UK Gilt rates. Overall, our analysis suggests that US Treasury Bills react to information in the aforementioned news releases before their announcement while UK Gilt yields react after them and that the Fed and Bank of England react similarly around major economic events.

The unintended consequence of English votes for English laws

The Scotland Bill 2015–16 would make the Scottish government one of the most powerful sub-central governments in the OECD in terms of its control over spending and taxation. The UK government has also announced plans to introduce ‘English Votes for English Laws’ (EVEL), where the support of a majority of English MPs would be necessary to pass legislation deemed to impact on England only. The objective of this paper is to examine the potential for spillovers to arise in monetary unions of asymmetric nations where fiscal policy choices are taken locally. We extend a model of Chari and Kehoe (2008) to show the sub-optimal consequences of devolved fiscal policy in a moneteary union with a dominant member state. Because England is so much larger than the other constituent nations of the UK, its fiscal policy choices will have a commensurately stronger impact on UK monetary policy. As a result, UK monetary policy might be inappropriate for the smaller nations, calling into question the economic efficiency of EVEL. This is a general result which arises from the asymmetry of nations rather than specific UK funding arrangements or behavioural responses.

Monetary policy in times of crisis: Pragmatism and conflict

Duncan Needham UK Monetary Policy from Devaluation to Thatcher, 1967-1982, Palgrave Macmillan: Basingstoke, 2014; 272 pp.: 9781137369536. 70 [pounds sterling] (hbk) Duncan Needham has not written a particularly long book, but you may be forgiven for thinking it was, considering the sheer density of the information packed within. Drawing heavily from Bank of England and Treasury archives from the late 1960s to the early 1980s, the author presents an incredibly detailed history of Britain's monetary policy development during a period of severe economic duress. The microscopic attention paid to the main policymakers, academics and commentators of this period is the great achievement of this book. Yet it is also its weakness, since at points Needham is in danger of ascribing too much causal power over the broad economic dynamics of this era to the ideas and actions of these individuals. The slowdown of the post-war boom presented novel and often contradictory challenges for British policymakers, prompting them to rummage in their toolboxes in search of new strategies for alleviating these pressures. Bank official Christopher Dow wrote in 1976 that the 'night-time electrocardiogram recordings of those whose daytime duties gave them close concern with the British balance of payments over the years ... would surely show more disturbance than other peoples' (Dow 2013: 47). As inflation and the money supply began to creep upwards from the late 1960s, further eroding British capital's competitive position, monetary policy became a central site of innovation and contestation. The period from 1967 to 1984--the focus of this book--was one of particularly desperate experimentation with the ideas of a group of economists proposing a new quantity theory of money. Needham's account starts with the formulation of Competition and Credit Control (CCC)--the first major financial deregulation in postwar history--in the years leading up to 1971. To supplement the positive effects of the 1967 sterling devaluation on the current account, monetary policy was tightened; but when this proved insufficient Chancellor Callaghan went to the IMF for the first of a series of loans. These loans came with progressively stricter conditionalities, especially regarding money supply targets. This sparked vigorous debate between the Bank, Treasury and IMF regarding the merits and feasibility of monetary targeting. At the same time, the traditional clearing banks--the institutions British monetary policy was chiefly designed to regulate--were rapidly losing market share to new 'secondary banks', such as building societies, undermining the effectiveness of many of the Banks monetary tools. Most importantly, lending ceilings were becoming increasingly unworkable and painful to impose. In this respect, the evidence presented supports the thesis advanced by Moran (1984). Needham carefully examines the interplay between the Bank's practical knowledge and academic monetarism, as policymakers desperately sought to reframe policy in line with changing conditions. Another catalyst for the monetary policy transformation of CCC was the Bank's frustration with the Treasury and Ministers--a recurring theme throughout the book. After the election of the Conservative Heath government in 1970, Bank officials expected that their requests for high er interest rates to combat inflation would meet a warmer reception; yet they were mistaken. Heath and Chancellor Barber were keen that British capital should utilise its excess capacity, which would not be aided by either more expensive credit or a stronger pound, leading them to reject the Bank's pleas. Needham charts how such stinging rebukes further spurred Bank officials' desperation to circumvent the traditional avenues of monetary control, through the working groups set up in the wake of the IMF consultations. (1) The result was the basic framework of CCC, designed to shift emphasis away from clumsy quantitative lending ceilings towards more flexible use of interest rates to control the broad money supply. …

Purchasing Power Parity Between the UK and Germany: The Euro Era

We use the Johansen cointegration approach to assess the empirical validity of the purchasing power parity (PPP) between the UK and Germany since the introduction of the euro. We conduct the empirical analysis in the context of the global financial crisis that began in 2007 and find that it directly affects the cointegration space. We fail to validate the Johansen and Juselius (1992) original hypothesis that nonstationarity of PPP associates with the nonstationarity of interest rate differentials to produce a stationary relation. On the other hand, we do not reject PPP. We find that PPP cointegrates with inflation differentials. We also find, contrary to conventional wisdom, that (i) equilibrium adjustment occurs between the German and UK inflation rates, while weak exogeneity exists for the German and UK interest rates and the PPP condition, and (ii) three common trends associated with the German interest rate the UK interest rate, and the PPP condition “push” the system with the German interest rate and the PPP condition playing dominant roles in affecting inflation in both Germany and the UK. These results cast serious doubt on the presumed independence of the UK monetary policy.

Key aspects of longer-term asset purchase programs in UK and US monetary policy

This paper considers several key aspects of recent central bank purchase programs involving longer-term government securities in the United States (where the programs are termed ‘large-scale asset purchases’) and the United Kingdom (where the programs are labeled ‘asset purchases financed by the issuance of central bank reserves’, or ‘quantitative easing’). Aspects of the purchase programs discussed include the scale of the programs, the historical and institutional background behind the programs, their effects on long-term interest rates and the equivalent effect expressed in terms of policy rates, and the reaction of aggregate demand to the programs. An analysis of the early stages of the economic recovery suggests that, by bolstering nominal spending and purchasing power, the asset purchases helped to secure positive real growth in the United Kingdom in 2010 in the face of adverse price-level shocks.

Financial crises and monetary policy: Evidence from the UK

We analyse UK monetary policy using monthly data for 1992–2010. We have two main findings. First, the Taylor rule breaks down after 2007 as the estimated response to inflation falls markedly and becomes insignificant. Second, policy is best described as a weighted average of a “financial crisis” regime in which policy rates respond strongly to financial stress and a “no-crisis” Taylor rule regime. Our analysis provides a clear explanation for the deep cuts in policy rates beginning in late 2008 and highlights the dilemma faced by policymakers in 2010–11.

Realized and Optimal Monetary Policy Rules in an Estimated Markov‐Switching DSGE Model of the United Kingdom

This paper investigates underlying changes in the UK economy over the past 35 years using a small open economy dynamic stochastic general equilibrium model. Using Bayesian analysis, we find UK monetary policy, nominal price rigidity and exogenous shocks, are all subject to regime shifts. A model incorporating these changes is used to estimate the realized monetary policy and derive the optimal monetary policy rule for the United Kingdom. This allows us to assess the effectiveness of the realized policy in terms of stabilizing economic fluctuations, and, in turn, provide an indication of whether there is room for the monetary authorities to further improve their policies.

UK Monetary Policy Change During the Financial Crisis: Paradigms, Spillovers, and Goal Co-ordination

AbstractPolicy responses to the tumult of the global financial crisis of 2007–9 prompt a consideration of the critical dimensions in specifying policy change. UK monetary policy between 2007 and 2009 is characterised by a remarkable degree of innovation yet counts as a ‘normal’ period of policy making under the Hall (1993) framework of policy change, the enduring workhorse of the comparative public policy field. This exposes its lack of conceptual refinement in describing significant but within paradigm policy change. This paper traces this failing to the notion of a policy paradigm, both its scale and the ideational mechanisms which bind policy change. The paper develops the UK monetary policy case to consider the potential of the recently-minted concept of a thermostatic policy institution for the development of Hall's framework; but finds analytical limitations in coping with significant policy spillovers. Suggestions are made to meet this important challenge for future research in policy studies on the specification of policy change.

The optimal neglect of inflation: An alternative interpretation of UK monetary policy during the “Great Moderation”

This paper argues that UK monetary policymakers did not respond to the inflation rate during most of the “Great Moderation” that ran from the early 1990s to the mid-2000s. We derive a generalisation of the New Keynesian Phillips curve in which inflation is a non-linear function of the output gap and show that the optimal response of the policy rule to inflation depends on the slope of the Phillips curve; if this is flat, manipulation of aggregate demand through monetary policy does not affect inflation and so policymakers cannot affect inflation. We estimate the monetary policy rules implied by a variety of alternative Phillips curves; our preferred model is based on a Phillips curve that is flat when output is close to equilibrium. We find that policy rates do not respond to inflation when the output gap is small, a situation that characterised most of the “Great Moderation” period.

Monetary Policy Under Labour

This paper analyses Labour's record on monetary policy and the record of the MPC which it created. The paper begins by discussing the conceptual framework and institutions behind inflation targeting as it operates in the UK. We then discuss the successes that it enjoyed up to 2007 and debate the lessons that are being learned as a consequence of the experience since then. We then raise some of the formidable challenges that UK monetary policy must now face up to including maintaining the credibility of the inflation targeting regime in the face of greater interdependence between monetary and fiscal policy, and between monetary policy and support to the banking system and financial markets.

The inflation-targeting regime in the United Kingdom: a view from Threadneedle Street

The recent financial crisis and subsequent deterioration in macroeconomic outcomes have raised question marks over the framework for monetary policy in the United Kingdom. This paper examines the performance of the UK's monetary policy framework in the light of these questions. Far from concluding that inflation targeting needs to be replaced, we argue in the paper that the regime has provided a clear policy compass that facilitated strong and decisive monetary policy decisions during the financial crisis. We argue that it should remain the mainstay of the UK macroeconomic policy framework. Even so, lessons need to be learnt to prevent financial market excesses from destabilizing the economy in future: the single most important being the need to expand the range of instruments available to policy-makers. Copyright 2010, Oxford University Press.

A decade of dissent: explaining the dissent voting behavior of Bank of England MPC members

We examine the dissent voting record of the Bank of England Monetary Policy Committee. Contrary to findings in the FOMC literature (for example Havrilesky and Schweitzer in The Political Economy of American Monetary Policy, pp. 197–210, 1990; Chappell et al. in Q. J. Econ. 108(1):185–218, 1993), the effects of members’ career backgrounds and the political channel of appointment on voting behavior are negligible, reflecting the distinct institutional constraints and incentives associated with UK monetary policy. Our findings also suggest that literature which characterizes voting behavior as being predominantly determined by members’ internal or external status is overly simplistic. This view is supported by econometric results appertaining to the introduction of member-specific fixed-effects, which account for possible unobserved heterogeneity.