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The Policy Window: The Impact of Financial Stress in the UK

Author

Listed:
  • A H Ahmad

    (University of Bath)

  • Christopher Martin

    (University of Bath)

  • Costas Milas

    (University of Liverpool
    Rimini Centre for Economic Analysis)

Abstract

We investigate the impact of financial stress on output, inflation and monetary policy in the UK since 1992 using a nonlinear Bayesian VAR model that distinguishes between regimes of low- and high-financial stress. We find that (a) the UK was in the high-stress regime during the financial crises of 1998–2001 and 2007–2012 but was in the low-stress regime in the rest of the “great moderation” period; (b) positive shocks to financial stress in the high-stress regime lead to sharp and sustained falls in the output gap, inflation and the policy rate; (c) financial stress shocks have little impact in the low-stress regime; (d) the impact of other macroeconomic shocks is stronger in periods of high financial stress; (e) increased financial stress reduced inflation and the output gap by up to 2 percentage points in 2008–2010; (f) financial stress can be monitored against the estimated threshold beyond which it has adverse effects; (g) there is a “policy window” of at least 4 months in which policymakers can respond to increased financial stress before it affects the wider economy.

Suggested Citation

  • A H Ahmad & Christopher Martin & Costas Milas, 2014. "The Policy Window: The Impact of Financial Stress in the UK," Department of Economics Working Papers 17/14, University of Bath, Department of Economics.
    • Handle: RePEc:eid:wpaper:39838
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    Cited by:

    1. Ahmad Hassan Ahmad & Eric J. Pentecost, 2020. "Testing the ‘Fear of Floating’ Hypothesis: A Statistical Analysis for Eight African Countries," Open Economies Review, Springer, vol. 31(2), pages 407-430, April.
    2. Ellington, Michael & Milas, Costas, 2019. "Global liquidity, money growth and UK inflation," Journal of Financial Stability, Elsevier, vol. 42(C), pages 67-74.

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