Modelling Monetary Policy: Inflation Targeting in Practice

This paper estimates a simple structural model of monetary policy in the UK focusing on the policy of inflation targeting introduced in 1992. We find that: (i) the adoption of inflation targeting led to significant changes in monetary policy; (ii) post-1992 monetary policy is asymmetric as policy-makers respond more to upward deviation of inflation away from the target; (iii) post-1992 policy-makers may be attempting to keep inflation within the 1.4%–2.6% range rather than pursuing a point target of 2.5% and (iv) the response of monetary policy to inflation is nonlinear as interest rates respond more when inflation is further from the target.