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Nonlinear interest rate reaction functions for the UK

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  • Brüggemann, Ralf
  • Riedel, Jana

Abstract

We empirically analyze Taylor-type equations for short-term interest rates in the United Kingdom using quarterly data from 1970Q1 to 2006Q2. Starting from strong evidence against a simple linear Taylor rule, we model nonlinearities using logistic smooth transition regression (LSTR) models. The LSTR models with time-varying parameters consistently track actual interest rate movements better than a linear model with constant parameters. Our preferred LSTR model uses lagged interest rates as a transition variable and suggests that in times of recessions the Bank of England puts more weight on the output gap and less so on inflation. A reverse pattern is observed in non-recession periods. Parameters of the model change less frequently after 1992, when an inflation target range was announced. We conclude that for the analysis of historical monetary policy, the LSTR approach is a viable alternative to linear reaction functions.

Suggested Citation

  • Brüggemann, Ralf & Riedel, Jana, 2011. "Nonlinear interest rate reaction functions for the UK," Economic Modelling, Elsevier, vol. 28(3), pages 1174-1185, May.
  • Handle: RePEc:eee:ecmode:v:28:y:2011:i:3:p:1174-1185
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    References listed on IDEAS

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    Cited by:

    1. Beckmann, Joscha & Belke, Ansgar & Dreger, Christian, 2017. "The relevance of international spillovers and asymmetric effects in the Taylor rule," The Quarterly Review of Economics and Finance, Elsevier, vol. 64(C), pages 162-170.
    2. baaziz, yosra, 2016. "Les règles de Taylor à l’épreuve de la révolution : cas de l’Égypte
      [The Taylor rule to the test of the revolution: the case of Egypt]
      ," MPRA Paper 69779, University Library of Munich, Germany.
    3. ZHENG, Tingguo & WANG, Xia & GUO, Huiming, 2012. "Estimating forward-looking rules for China's Monetary Policy: A regime-switching perspective," China Economic Review, Elsevier, vol. 23(1), pages 47-59.
    4. Damette, Olivier, 2016. "Mixture Distribution Hypothesis And The Impact Of A Tobin Tax On Exchange Rate Volatility: A Reassessment," Macroeconomic Dynamics, Cambridge University Press, vol. 20(06), pages 1600-1622, September.
    5. repec:gam:jecomi:v:4:y:2016:i:2:p:6:d:67984 is not listed on IDEAS
    6. Chen, Hongyi & Funke, Michael & Lozev, Ivan & Tsang, Andrew, 2017. "To guide or not to guide? Quantitative monetary policy tools and macroeconomic dynamics in China," BOFIT Discussion Papers 3/2017, Bank of Finland, Institute for Economies in Transition.
    7. Ahmad, Saad, 2016. "A multiple threshold analysis of the Fed's balancing act during the Great Moderation," Economic Modelling, Elsevier, vol. 55(C), pages 343-358.
    8. Yosra Baaziz & Moez Labidi, 2016. "Nonlinear Monetary Policy Rules: An Essay in the Comparative Study on Egyptian and Tunisian Central Banks," Economies, MDPI, Open Access Journal, vol. 4(2), pages 1-18, April.

    More about this item

    Keywords

    Interest rate reaction functions Smooth transition regression model Monetary policy;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • 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

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