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United Kingdom Inflation Targeting and the Exchange Rate

Listed author(s):
  • Christopher Allsopp
  • Amit Kara
  • Edward Nelson

The UK'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. It is appropriate to model imports as intermediate goods rather than goods consumed directly by households. This leads to a simpler transmission mechanism of monetary policy while also offering a sustainable explanation of the weakness of the exchange rate/inflation relationship and making consumer price inflation an appropriate monetary policy target. Copyright 2006 Royal Economic Society.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1468-0297.2006.01098.x
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Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 116 (2006)
Issue (Month): 512 (06)
Pages: 232-244

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Handle: RePEc:ecj:econjl:v:116:y:2006:i:512:p:f232-f244
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References listed on IDEAS
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  1. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  2. Galí, Jordi & Monacelli, Tommaso, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," CEPR Discussion Papers 3346, C.E.P.R. Discussion Papers.
  3. Sbordone, A.M., 1998. "Prices and Unit Labor Costs: a New Test of Price Stickiness," Papers 653, Stockholm - International Economic Studies.
  4. McCallum, Bennett T. & Nelson, Edward, 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Seminar Papers 644, Stockholm University, Institute for International Economic Studies.
  5. Wilson, Thomas, 1976. "Effective Devaluation and Inflation," Oxford Economic Papers, Oxford University Press, vol. 28(1), pages 1-24, March.
  6. McCallum, Bennett T & Nelson, Edward, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimizing Agents and Sticky Prices," CEPR Discussion Papers 2756, C.E.P.R. Discussion Papers.
  7. Amit Kara & Edward Nelson, 2002. "The Exchange Rate and Inflation in the UK," Discussion Papers 11, Monetary Policy Committee Unit, Bank of England.
  8. Richard Clarida & Jordi Gali & Mark Gertler, 2002. "A Simple Framework for International Monetary Policy Analysis," NBER Working Papers 8870, National Bureau of Economic Research, Inc.
  9. Jose Manuel Campa & Linda S. Goldberg, 2002. "Exchange rate pass-through into import prices: a macro or micro phenomenon?," Staff Reports 149, Federal Reserve Bank of New York.
  10. Devereux, Michael B. & Engel, Charles, 2002. "Exchange rate pass-through, exchange rate volatility, and exchange rate disconnect," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 913-940, July.
  11. 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.
  12. 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.
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