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The Exchange Rate and Inflation in the UK

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Author Info
Kara, Amit
Nelson, Edward

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Abstract

The United Kingdom is a highly open economy, and has a monetary policy strategy of targeting inflation in consumer prices. In this Paper, we look at the evidence from the UK on inflation behaviour, and examine the propositions from several theoretical models about inflation dynamics in an open economy, focusing in particular on the hypothesised connections between the exchange rate and consumer price inflation. Theoretical open-economy macroeconomic models ‘cover the waterfront’ on this issue, ranging from ‘exchange rate disconnect’ to a rigid link between nominal exchange rate changes and inflation. We estimate on UK data the open-economy Phillips curves implied by the alternative explanations. We argue that, of the alternatives considered, only a model where imports are modelled as an intermediate good, as in McCallum and Nelson (1999), provides a reasonable match with the data. Unlike the standard model, in which imports are treated as a final consumer good, the intermediate-goods specification provides support for a policy of CPI inflation targeting.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3783.

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Date of creation: Feb 2003
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Handle: RePEc:cpr:ceprdp:3783

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Related research
Keywords: cpi inflation targeting exchange-rate pass-through intermediate goods monetary policy rules UK inflation

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Find related papers by JEL classification:
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Patrizio Tirelli & V. Anton Muscatelli & Carmine Trecroci, 2004. "The interaction of fiscal and monetary policies: some evidence using structural econometric models'," Money Macro and Finance (MMF) Research Group Conference 2003 103, Money Macro and Finance Research Group. [Downloadable!]
  2. V. Anton Muscatelli & Patrizio Tirelli & Carmine Trecroci, 2004. " Fiscal and Monetary Policy Interactions in a New Keynesian Model with Liquidity Constraints," CDMA Conference Paper Series 0402, Centre for Dynamic Macroeconomic Analysis. [Downloadable!]
    Other versions:
  3. Rebecca Driver & Stephen Millard, 2004. "Exchange rates, commodities and the implications of volatility in a small open economy world," Money Macro and Finance (MMF) Research Group Conference 2003 26, Money Macro and Finance Research Group. [Downloadable!]
  4. Michael Arghyrou & Christopher Martin & Costas Milas, 2003. "Non-linear Inflationary Dynamics: Evidence from the UK," Public Policy Discussion Papers 03-03, Economics and Finance Section, School of Social Sciences, Brunel University. [Downloadable!]
    Other versions:
  5. V. Anton Muscatelli & Tiziano Ropele & Patrizio Tirelli, 2004. "Macroeconomic Adjustment in the Euro-area: The Role of Fiscal Policy," Working Papers 2005_20, Department of Economics, University of Glasgow, revised May 2005. [Downloadable!]
  6. Christopher Allsopp, 2002. "Macroeconomic Policy Rules in Theory and in Practice," Discussion Papers 10, Monetary Policy Committee Unit, Bank of England. [Downloadable!]
  7. Anton Muscatelli & Patrizio Tirelli & Carmine Trecroci, 2003. "Fiscal and Monetary Policy Interactions: Empirical Evidence and Optimal Policy Using a Structural New Keynesian Model," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
    Other versions:
  8. Campbell Leith & Simon Wren-Lewis, 2002. "Taylor Rules in the Open Economy," Working Papers 2002_14, Department of Economics, University of Glasgow. [Downloadable!]
  9. Anton Muscatelli & Patrizio Tirelli & Carmine Trecroci, 2004. "Can Fiscal Policy Help Macroeconomic Stabilisation? Evidence from a New Keynesian Model with Liquidity Constraints," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
  10. Peter Tinsley & Sharon Kozicki, 2003. "Alternative Sources of the Lag Dynamics of Inflation," Computing in Economics and Finance 2003 92, Society for Computational Economics. [Downloadable!]
    Other versions:
  11. Alessandro Flamini, 2004. "Inflation Targeting and Exchange Rate Pass-Through," HEI Working Papers 04-2004, Economics Section, The Graduate Institute of International Studies. [Downloadable!]
  12. Christopher Martin & Costas Milas, 2006. "The Impact of Uncertainty on Monetary Policy Rules in the UK," Keele Economics Research Papers KERP 2006/09, Centre for Economic Research, Keele University. [Downloadable!]
  13. Christopher Allsopp & Amit Kara & Edward Nelson, 2006. "U.K. inflation targeting and the exchange rate," Working Papers 2006-030, Federal Reserve Bank of St. Louis. [Downloadable!]
  14. Janko Gorter, 2005. "Subjective Expectations and New Keynesian Phillips Curves in Europe," DNB Working Papers 049, Netherlands Central Bank, Research Department. [Downloadable!]
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