Financial crises and monetary policy: Evidence from the UK

Abstract

We analyse UK monetary policy using monthly data for 1992-2010. We have two main findings. First, the Taylor rule breaks down after 2007 as the estimated response to inflation falls markedly and becomes insignificant. Second, policy is best described as a weighted average of a "financial crisis" regime in which policy rates respond strongly to financial stress and a "no-crisis" Taylor rule regime. Our analysis provides a clear explanation for the deep cuts in policy rates beginning in late 2008 and highlights the dilemma faced by policymakers in 2010-11.

Threshold effects of financial stress on monetary policy rules: A panel data analysis

“…We relax the assumption of both linearity and the existence of a functional form and allow the interest rate reaction function to switch according to an observable signal in a panel of AE and EMEs. This paper complements previous studies on the effect of financial variables on the interest rate reaction function of central banks (see Bernanke and Gertler, 2001;Lubik and Schorfheide, 2007;Martin and Milas, 2013;Baxa et al, 2013) and on papers that employ dynamic panel threshold regressions, an econometric method that has been gaining much attention from applied researchers in recent years (see for example, Kremer et al, 2013;Proaño et al, 2014). We highlight three main contributions to the literature that are both empirical and methodological.…”

Monetary Policy and Alternative Measures of Inflation: Empirical Evidence for the UK

“…Stable policy rules have previously been estimated for this sample period (Mihailov, 2006;Martin, Milas, 2010). There is also a strong evidence of a change in the monetary policy rule in the UK (and other developed economies) from the summer of 2007 as Central Banks faced the unprecedented challenge of the Global Financial crisis (Martin, Milas, 2013). A model of monetary policy in this period would require a detailed analysis of the stability of the financial system and solvency of the banking sector, which is beyond the scope of this paper.…”

The Taylor Rule and Financial Stability – A Literature Review with Application for the Eurozone

“…Interestingly, his results are reversed for the Fed and the BOE, neither of which react to the index but rather to the spread. More work related to spreads is given by Martin and Milas (2013). Using subsamples for the U.K. from 1992-2010, the authors find that the BOE's reaction to inflation and output became insignificant and decreased respectively during the subprime crisis.…”