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

Ahmad Hassan Ahmad, Chris Martin, Costas Milas

Research output: Working paper / PreprintWorking paper

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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.
Original languageEnglish
Place of PublicationBath, U. K.
PublisherDepartment of Economics, University of Bath
Number of pages30
Publication statusPublished - 2014

Publication series

NameBath Economics Research Working Papers
PublisherDepartment of Economics, University of Bath


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