The optimal neglect of inflation: an alternative interpretation of UK monetary policy during the “Great Moderation”

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Abstract

This paper argues that UK monetary policymakers did not respond to the inflation rate during most of the “Great Moderation” that ran from the early 1990s to the mid-2000s. We derive a generalisation of the New Keynesian Phillips curve in which inflation is a nonlinear function of the output gap and show that the optimal response of the policy rule to inflation depends on the slope of the Phillips curve; if this is flat, manipulation of aggregate demand through monetary policy does not affect inflation and so policymakers cannot affect inflation. We estimate the monetary policy rules implied by a variety of alternative Phillips curves; our preferred model is based on a Phillips curve that is flat when output is close to equilibrium. We find that policy rates do not respond to inflation when the output gap is small, a situation that characterised most of the “great moderation” period.
Original languageEnglish
Pages (from-to)982-992
Number of pages11
JournalJournal of Macroeconomics
Volume32
Issue number4
DOIs
Publication statusPublished - Dec 2010

Keywords

  • non-linearity
  • monetary policy
  • Phillips curve

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