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A small structural empirical model of the UK monetary transmission mechanism

  • Shamik Dhar
  • Darren Pain
  • Ryland Thomas

In this paper a structural empirical model of the UK monetary transmission mechanism is estimated, which can be used for policy analysis and forecasting. A small system is estimated containing eight variables that theoretically have an important role in the transmission mechanism. The paper then attempts to decompose the movements of each of these variables into a small number of independent underlying forcing processes or 'shocks', with a well-defined economic interpretation. In addition to identifying shocks to productivity, domestic demand, external demand and the foreign exchange risk premium, the paper distinguishes between several types of monetary shock. In particular, a distinction is made between 'permanent' monetary policy shocks, attributable to changes in the underlying nominal target of the authorities, and 'temporary' policy shocks, reflecting either policy 'errors' or transitory deviations from the authorities' reaction function. A financial intermediation shock is also identified reflecting changes in the provision of credit by the banking system and the degree of financial liberalisation. The paper goes on to demonstrate some of the practical uses of the model, which include estimating output and liquidity gaps, historical decompositions of the data and conditional forecasting.

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Paper provided by Bank of England in its series Bank of England working papers with number 113.

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Date of creation: May 2000
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Handle: RePEc:boe:boeewp:113
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  1. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  2. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
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  14. Mellander, Erik & Vredin, A & Warne, A, 1992. "Stochastic Trends and Economic Fluctuations in a Small Open Economy," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 7(4), pages 369-94, Oct.-Dec..
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  17. Hallman, Jeffrey J & Porter, Richard D & Small, David H, 1991. "Is the Price Level Tied to the M2 Monetary Aggregate in the Long Run?," American Economic Review, American Economic Association, vol. 81(4), pages 841-58, September.
  18. Shamik Dhar & Stephen P Millard, 2000. "A limited participation model of the monetary transmission mechanism in the United Kingdom," Bank of England working papers 117, Bank of England.
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