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A small structural empirical model of the UK monetary transmission mechanism

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Shamik Dhar
Darren Pain
Ryland Thomas

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Abstract

In this paper a structural empirical model of the UK monetary transmission mechanism is estimated, which can be used for policy analysis and forecasting. A small system is estimated containing eight variables that theoretically have an important role in the transmission mechanism. The paper then attempts to decompose the movements of each of these variables into a small number of independent underlying forcing processes or 'shocks', with a well-defined economic interpretation. In addition to identifying shocks to productivity, domestic demand, external demand and the foreign exchange risk premium, the paper distinguishes between several types of monetary shock. In particular, a distinction is made between 'permanent' monetary policy shocks, attributable to changes in the underlying nominal target of the authorities, and 'temporary' policy shocks, reflecting either policy 'errors' or transitory deviations from the authorities' reaction function. A financial intermediation shock is also identified reflecting changes in the provision of credit by the banking system and the degree of financial liberalisation. The paper goes on to demonstrate some of the practical uses of the model, which include estimating output and liquidity gaps, historical decompositions of the data and conditional forecasting.

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Paper provided by Bank of England in its series Bank of England working papers with number 113.

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  3. Pesaran,H.M. & Shin,Y., 1995. "Long-Run Structural Modelling," Cambridge Working Papers in Economics 9419, Faculty of Economics, University of Cambridge.
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  4. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March. [Downloadable!] (restricted)
  5. Rose, Andrew Kenan, 1988. " Is the Real Interest Rate Stable?," Journal of Finance, American Finance Association, vol. 43(5), pages 1095-1112, December. [Downloadable!] (restricted)
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  8. Mellander, Erik & Vredin, A & Warne, A, 1992. "Stochastic Trends and Economic Fluctuations in a Small Open Economy," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(4), pages 369-94, Oct.-Dec.. [Downloadable!] (restricted)
  9. Wickens, Michael R., 1996. "Interpreting cointegrating vectors and common stochastic trends," Journal of Econometrics, Elsevier, vol. 74(2), pages 255-271, October. [Downloadable!] (restricted)
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  11. Shamik Dhar & Stephen P Millard, . "A limited participation model of the monetary transmission mechanism in the United Kingdom," Bank of England working papers 117, Bank of England. [Downloadable!]
  12. Hallman, Jeffrey J & Porter, Richard D & Small, David H, 1991. "Is the Price Level Tied to the M2 Monetary Aggregate in the Long Run?," American Economic Review, American Economic Association, vol. 81(4), pages 841-58, September. [Downloadable!] (restricted)
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  14. Andrew Brigden & Paul Mizen, . "Money, credit and investment in UK corporate sector," Bank of England working papers 100, Bank of England. [Downloadable!]
  15. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254. [Downloadable!] (restricted)
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  1. Céline Gauthier & Fu Chun Li, 2006. "Linking Real Activity and Financial Markets: The Bonds, Equity, and Money (BEAM) Model," Working Papers 06-42, Bank of Canada. [Downloadable!]
  2. Shamik Dhar & Stephen P Millard, . "How well does a limited participation model of the monetary transmission mechanism match UK data?," Bank of England working papers 118, Bank of England. [Downloadable!]
  3. Martha Misas Arango & Enrique López Enciso & Diego Vásquez Escobar, . "Tendencias Estocásticas Comunes y Fluctuaciones en la Economía Colombiana: 1950-2002," Borradores de Economia 275, Banco de la Republica de Colombia. [Downloadable!]
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  4. Celine Gauthier & Virginie Traclet, 2004. "Do Domestic Macroeconomic Factors Play a Role in Determining Long-Term Nominal Interest Rates? Application in the Case of a Small Open-Economy," Money Macro and Finance (MMF) Research Group Conference 2004 90, Money Macro and Finance Research Group. [Downloadable!]
  5. Mark S Astley & Tony Yates, . "Inflation and real disequilibria," Bank of England working papers 103, Bank of England. [Downloadable!]
  6. Shamik Dhar & Stephen P Millard, . "A limited participation model of the monetary transmission mechanism in the United Kingdom," Bank of England working papers 117, Bank of England. [Downloadable!]
  7. Vittorio Corbo & José A. Tessada, 2003. "Growth and Adjustment in Chile: a Look at the 1990s," Working Papers Central Bank of Chile 204, Central Bank of Chile. [Downloadable!]
  8. Paolo PAESANI, 2003. "Will the Monetary Pillar Stay? A Few Lessons from the UK," Economics Working Papers ECO2003/10, European University Institute. [Downloadable!]
  9. Annick Bruggeman & Marie Donnay, 2003. "A monthly monetary model with banking intermediation for the euro area," Working Paper Series 264, European Central Bank. [Downloadable!]
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