Inflation Targeting in the United Kingdom

Table of Contents

1 Abstract

2 Modelling Inflation Targeting

2.1 Introduction

2.2 Monetary Policy

2.2.1 Monetary Policy Strategies in Theory

2.2.2 Monetary Stability as an Aim of Monetary Policy

2.2.3 Empirical Monetary Strategies

2.2.4 Monetary Transmission Mechanisms

2.3 Inflation Targeting as Monetary Policy Strategy

2.3.1 Characterisation

2.3.2 The Origins

2.3.3 On Transparency

2.3.4 Form of the Target and the Policy Horizon

2.3.5 Asset Price Bubbles and Rapid Expansion of Credit

2.3.6 Critical Discussion

2.4 The Instrument Rule Model

2.4.1 Modelling Inflation Targeting

2.4.2 Kydland and Prescott’s Time Consistency Problem

2.4.3 Barro and Gordon Introduce Reputation to the Game

2.4.4 McCallum and the Monetary Base

2.4.5 The Taylor Rule For Interest Rate Setting

2.4.6 Asymmetric Preferences and Non-linear Taylor Rules

2.4.7 Summary

2.5 The Target Rule Model

2.5.1 Svensson’s Model in the New Keynesian Framework

2.5.2 Some Aspects in Critical Discussion

2.6 Summary

3 The Process of Inflation Targeting in the UK

3.1 Some Historical Issues

3.1.1 Development of the Bank of England

3.1.2 Previous Monetary Policy Regimes

3.1.3 Adoption of Inflation Targeting

3.1.4 Operational Framework from 1992 - 1997

3.1.5 Bank of England Operational Independence

3.1.6 Summary

3.2 Present Monetary Policy Framework at the Bank of England

3.2.1 Core Purposes and Monetary Strategy

3.2.2 The Bank’s Publication Policy

3.2.3 Forecasting Inflation at the Bank of England

3.3 Bank of England Transmission Mechanism

3.3.1 The Transmission Mechanism in Overview

3.3.2 Interest Rate Setting Process and Quantitative Effects

3.3.3 Financial Markets and Spending Behaviour

3.3.4 From Changes in Spending Behaviour to GDP and Inflation

3.3.5 The Role of Money

3.3.6 Relationship between Inflation and Inflation Expectations

3.4 Effects of Inflation Targeting in the United Kingdom

3.4.1 Introduction

3.4.2 Basic Economic Developments After Inflation Targeting

3.4.3 Inflation Targeting and the Exchange Rate

3.4.4 Empirical Evidence of a Non-linear Taylor Rule

3.4.5 Efficacy and Impact on Social Welfare

3.4.6 Inflation Targeting and The Household Sector After the Financial Crisis

3.4.7 Expected Inflation as a Metric of Heightened Credibility

3.5 Concluding Remarks

4 Conclusion

Objectives and Research Focus

This thesis examines the theoretical foundations of inflation targeting as a monetary policy strategy and evaluates its practical implementation and economic impacts within the United Kingdom. The primary research goal is to understand how inflation targeting has influenced the British economy, specifically regarding price stability, institutional transparency, and the Bank of England's operational framework.

• Theoretical analysis of Monetarist versus New-Keynesian approaches to inflation targeting.
• Evaluation of operational frameworks, including the move toward Bank of England independence.
• Assessment of the monetary transmission mechanism and the role of inflation forecasts.
• Investigation into the empirical effectiveness of inflation targeting and its impact on social welfare.
• Examination of challenges posed by asset price bubbles and financial instability.

Excerpt from the Book

Chapter Summary

2 Modelling Inflation Targeting: This chapter reviews theoretical literature on inflation targeting, comparing different model specifications and the debate between rule-based and discretionary monetary policy.

3 The Process of Inflation Targeting in the UK: This chapter analyzes the historical evolution of the Bank of England's framework, including the transition to operational independence and the mechanisms used to control inflation.

4 Conclusion: The final chapter summarizes the findings, noting that while inflation targeting has improved transparency and stability, it faces ongoing challenges from asset price volatility and financial crises.

Keywords

Inflation Targeting, Bank of England, Monetary Policy, Price Stability, Taylor Rule, Financial Stability, Monetary Transmission Mechanism, Interest Rate Setting, Transparency, Credibility, Asset Price Bubbles, New-Keynesian Framework, Economic Growth, Central Bank Independence.

Frequently Asked Questions

What is the core focus of this research?

This work provides an in-depth analysis of inflation targeting as a monetary policy framework, with a specific focus on the development, implementation, and economic consequences of this strategy in the United Kingdom.

What are the central themes discussed in the thesis?

The key themes include the theoretical modeling of inflation targeting (instrument rules vs. target rules), the historical transformation of the Bank of England, the role of transparency, and the relationship between inflation targeting and broader financial stability.

What is the primary objective of the inflation targeting strategy?

The primary goal is the achievement and maintenance of low and stable inflation, which serves as a nominal anchor for the economy and facilitates long-term price stability.

Which scientific methods are employed?

The thesis utilizes a literature-based theoretical review, analyzing mathematical models (such as Taylor rules and Svensson’s models), alongside an empirical examination of institutional developments and historical economic data from the UK.

What topics are covered in the main section?

The main part covers the theoretical origins of inflation targeting, the operational framework of the Bank of England, the mechanics of the monetary transmission process, and an evaluation of the effects on the British economy.

Which keywords characterize this paper?

Key terms include Inflation Targeting, Bank of England, Monetary Policy, Taylor Rule, Financial Stability, and Central Bank Independence.

How does the Bank of England define 'monetary stability'?

Monetary stability is defined as maintaining stable prices and confidence in the currency, which the Bank achieves by setting interest rates to meet the government's inflation target.

What is the significance of the 1998 Bank of England Act?

This act was a revolutionary step that granted the Bank of England operational independence to set interest rates, thereby significantly enhancing its credibility and accountability in achieving inflation targets.

Does the paper conclude that inflation targeting is infallible?

No, the author notes that while inflation targeting has contributed to stability, recent challenges—such as asset price bubbles and financial crises—highlight the limitations and ongoing complexities of the framework.