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Time Horizons And Smoothing In the Bank of England's Reaction Function: The Contrast Between The Standard GMM And Ex Ante Forecast Approaches

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  • David Cobham
  • Yue Kang

Abstract

The monetary policy reaction function of the Bank of England is estimated by the standard GMM approach and the ex-ante forecast method developed by Goodhart (2005), with particular attention to the horizons for inflation and output at which each approach gives the best fit. The horizons for the ex-ante approach are much closer to what is implied by the Bank’s view of the transmission mechanism, while the GMM approach produces an implausibly slow adjustment of the interest rate, and suffers from a weak instruments problem. These findings suggest a strong preference for the ex-ante approach.

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Paper provided by Department of Economics, School of Management and Languages, Heriot Watt University in its series Heriot-Watt University Economics Discussion Papers with number 1208.

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Date of creation: 2012
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Handle: RePEc:hwe:hwuedp:1208

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