The Sub-Prime Crisis and UK Monetary Policy
AbstractThe “sub-prime” crisis, which led to major turbulence in global financial markets beginning in mid-2007, has posed major challenges for monetary policymakers. We analyse the impact on monetary policy of the widening differential between policy rates and the 3-month Libor rate, the benchmark for private sector interest rates. We show that the optimal monetary policy rule should include the determinants of this differential, adding an extra layer of complexity to the problems facing policymakers. Our estimates reveal significant effects of risk and liquidity measures, suggesting the widening differential between base rates and Libor was largely driven by a sharp increase in unsecured lending risk. We calculate that the crisis increased libor by up to 60 basis points; in response base rates fell further and quicker than would otherwise have happened as policymakers sought to offset some of the contractionary effects of the sub-prime crisis.
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Bibliographic InfoPaper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 31-08.
Date of creation: Jan 2008
Date of revision: Jan 2008
optimal monetary policy; sub-prime crisis;
Other versions of this item:
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- 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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-11-18 (All new papers)
- NEP-CBA-2008-11-18 (Central Banking)
- NEP-EEC-2008-11-18 (European Economics)
- NEP-FMK-2008-11-18 (Financial Markets)
- NEP-MAC-2008-11-18 (Macroeconomics)
- NEP-MON-2008-11-18 (Monetary Economics)
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