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The optimal neglect of inflation: An alternative interpretation of UK monetary policy during the "Great Moderation"

  • Boinet, Virginie
  • Martin, Christopher

This paper argues that UK monetary policymakers did not respond to the inflation rate during most of the "Great Moderation" that ran from the early 1990s to the mid-2000s. We derive a generalisation of the New Keynesian Phillips curve in which inflation is a non-linear function of the output gap and show that the optimal response of the policy rule to inflation depends on the slope of the Phillips curve; if this is flat, manipulation of aggregate demand through monetary policy does not affect inflation and so policymakers cannot affect inflation. We estimate the monetary policy rules implied by a variety of alternative Phillips curves; our preferred model is based on a Phillips curve that is flat when output is close to equilibrium. We find that policy rates do not respond to inflation when the output gap is small, a situation that characterised most of the "Great Moderation" period.

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Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 32 (2010)
Issue (Month): 4 (December)
Pages: 982-992

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Handle: RePEc:eee:jmacro:v:32:y:2010:i:4:p:982-992
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622617

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  1. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  2. Surico, Paolo, 2007. "The Fed's monetary policy rule and U.S. inflation: The case of asymmetric preferences," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 305-324, January.
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  8. Virginie Boinet & Christopher Martin, 2006. "The Perverse Response of Interest Rates," Economics and Finance Discussion Papers 06-20, Economics and Finance Section, School of Social Sciences, Brunel University.
  9. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "The science of monetary policy: A new Keynesian perspective," Economics Working Papers 356, Department of Economics and Business, Universitat Pompeu Fabra, revised Apr 1999.
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  13. Andrew J. Filardo, 1998. "New evidence on the output cost of fighting inflation," Economic Review, Federal Reserve Bank of Kansas City, issue Q III.
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