A BEJM Topics article.

Abstract

Owing to lags in the transmission mechanism of monetary policy, central banks put much weight on forecasts of the future paths of output and inflation. So there has been considerable recent interest in forward-looking Taylor-type reaction functions. Using publicly available data on the Monetary Policy Committee’s forecasts for UK inflation and output growth, 1997-2003, we examine how the coefficients in such reaction functions changed as we switched between ex post forecasts – those published after, and incorporating, the preceding interest rate decision – and ex ante forecasts – those presented to the MPC before that decision – and also as we vary the (forecast) horizon, out to eight quarters ahead. In our data set, the coefficients vary sensitively as the horizon/forecast basis changes. Our results are consistent with the hypothesis that the MPC tried aggressively to eliminate any predicted, ex ante, deviation of inflation from target immediately it emerged, with no apparent indication of intended inertia, or gradualism, in response. Nevertheless the time path of official short term interest rates during these years shows the usual record of consecutive similarly-signed small steps.

Submitted: June 30, 2004 · Accepted: June 29, 2005 · Published: August 2, 2005

Originally published in Topics in Macroeconomics.

Recommended Citation

Goodhart, Charles A.E. (2005) "The Monetary Policy Committee’s Reaction Function: An Exercise in Estimation," Topics in Macroeconomics: Vol. 5 : Iss. 1, Article 18.
Available at: http://www.bepress.com/bejm/topics/vol5/iss1/art18