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Monetary policy and stagflation in the UK

  • Edward Nelson
  • Kalin Nikolov

The volatile data for inflation, output, and interest rates in the United Kingdom prior to the 1990s, and the relative macroeconomic stability associated with inflation targeting, provide a rich basis for discriminating between rival explanations for the outbreak of stagflation. Alternative hypotheses are examined with the aid of a New Keynesian model of aggregate demand and inflation determination, estimated on quarterly UK data for 1959-2000. The model features IS and Phillips curves based on optimising behaviour, and fully incorporates the distinction between detrended output and the output gap stressed by optimising analysis. Using model simulations as well as information on the real-time views of policy-makers, alternative explanations are tested for the outbreak of inflation in the United Kingdom in the 1960s and 1970s. Inaccurate estimates of the degree of excess demand in the economy are found to have contributed significantly to the outbreak. But there is also evidence of a major role following from the failure at the time to recognise the importance of monetary policy, as opposed to non-monetary devices, in controlling inflation.

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Paper provided by Bank of England in its series Bank of England working papers with number 155.

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Date of creation: May 2002
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Handle: RePEc:boe:boeewp:155
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