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Monetary Policy, Beliefs, Unemployment and Inflation: Evidence from the UK

In: Palgrave Handbook of Econometrics

Author

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  • S. G. B. Henry

Abstract

Recent applied macroeconomic research has been concerned with the effects of both labor market reforms and the delegation of monetary policy to an inflation-averse central bank as ways of improving inflation and unemployment outcomes. The experiences of the UK following the introduction of changes to the labor market in the 1980s and of inflation targeting and instrument independence for the Bank of England in the 1990s, have often been held up as illustrations of the beneficial effects of regime changes of this sort. Others have contradicted these views, including those who have drawn attention to the weakness in the empirical evidence favoring effects from labor market reforms, and others who argue that a combination of beneficial international events and monetary policy mistakes have played an important part in the UK’s recent economic improvement. We review the case for regime change from either of these sources, labor market and monetary, in an application to the UK using a model that integrates both. The results indicate two things: the importance of allowing for the openness of the UK economy in “behavioral” econometric models of the natural rate, and the importance of allowing for policy “mistakes.” Based on our analysis, we conclude that recent changes in UK monetary policy or labor market institutions seem unlikely to have made an important contribution to the improvements in UK economic performance. Effects originating overseas appear to play an important role in unemployment changes in the UK. Policy mistakes have had important effects on inflation over the last two decades, and a proper allowance for these is needed before any firm judgments of the benefits of the delegation of monetary policy can be reached.

Suggested Citation

  • S. G. B. Henry, 2009. "Monetary Policy, Beliefs, Unemployment and Inflation: Evidence from the UK," Palgrave Macmillan Books, in: Terence C. Mills & Kerry Patterson (ed.), Palgrave Handbook of Econometrics, chapter 18, pages 917-948, Palgrave Macmillan.
  • Handle: RePEc:pal:palchp:978-0-230-24440-5_18
    DOI: 10.1057/9780230244405_18
    as

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