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U.K. inflation targeting and the exchange rate

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  • Christopher Allsopp
  • Amit Kara
  • Edward Nelson

Abstract

The United Kingdom*s monetary policy strategy is one of floating exchange rates and inflation forecast targeting, with the targeted measure referring to consumer prices. We consider whether it is welfare-reducing to target inflation in the CPI rather than in a narrower index; and the role of the exchange rate in the transmission of monetary policy actions to CPI inflation. We argue that it is appropriate to model imports as intermediate goods rather than as goods consumed directly by households. This leads to a simpler transmission mechanism of monetary policy, while also offering a sustainable explanation fore the weakness of the exchange rate/inflation relationship and making consumer price inflation an appropriate monetary policy target.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2006-030.

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Date of creation: 2006
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Publication status: Published in Economic Journal, June 2006, 116(512), pp. F232-44
Handle: RePEc:fip:fedlwp:2006-030

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Keywords: Inflation (Finance) - Great Britain ; Foreign exchange rates - Great Britain;

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References

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  1. Ben Bernanke & Mark Gertler, 2000. "Monetary Policy and Asset Price Volatility," NBER Working Papers 7559, National Bureau of Economic Research, Inc.
  2. Jose Manuel Campa & Linda S. Goldberg, 2002. "Exchange Rate Pass-Through into Import Prices: A Macro or Micro Phenomenon?," NBER Working Papers 8934, National Bureau of Economic Research, Inc.
  3. Amit Kara & Edward Nelson, 2003. "The Exchange Rate and Inflation in the UK," Scottish Journal of Political Economy, Scottish Economic Society, vol. 50(5), pages 585-608, November.
  4. Sbordone, Argia, 1998. "Prices and Unit Labor Costs: A New Test of Price Stickiness," Seminar Papers 653, Stockholm University, Institute for International Economic Studies.
  5. Christopher J. Erceg & Dale W. Henderson & Andrew T. Levin, 1999. "Optimal monetary policy with staggered wage and price contracts," International Finance Discussion Papers 640, Board of Governors of the Federal Reserve System (U.S.).
  6. Joseph E. Gagnon & Jane Ihrig, 2001. "Monetary policy and exchange rate pass-through," International Finance Discussion Papers 704, Board of Governors of the Federal Reserve System (U.S.).
  7. Campa, José Manuel & Goldberg, Linda S, 2004. "Exchange Rate Pass-Through into Import Prices," CEPR Discussion Papers 4391, C.E.P.R. Discussion Papers.
  8. Taylor, John B., 2000. "Low inflation, pass-through, and the pricing power of firms," European Economic Review, Elsevier, vol. 44(7), pages 1389-1408, June.
  9. Ravenna, Federico & Walsh, Carl E., 2006. "Optimal monetary policy with the cost channel," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 199-216, March.
  10. Vickers, John, 2000. "Monetary Policy and Asset Prices," Manchester School, University of Manchester, vol. 68(0), pages 1-22, Supplemen.
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Cited by:
  1. Guender, Alfred V., 2008. ""Leaning with the wind"? An open-economy example," Journal of Macroeconomics, Elsevier, vol. 30(3), pages 941-964, September.
  2. Roger Bjørnstad & Eilev S. Jansen, 2007. "The NOK/euro exhange rate after inflation targeting: The interest rate rules," Discussion Papers 501, Research Department of Statistics Norway.
  3. Guender, Alfred V., 2007. "The timeless perspective vs. discretion: theory and monetary policy implications for an open economy," Discussion Paper Series 1: Economic Studies 2007,29, Deutsche Bundesbank, Research Centre.

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