Time-Varying Inflation Expectations and Economic Fluctuations in the United Kingdom: A Structural VAR Analysis

49 Pages Posted: 3 Jun 2010

See all articles by Alina Barnett

Alina Barnett

Bank of England

Jan J. J. Groen

Federal Reserve Bank of New York

Haroon Mumtaz

University of London - School of Sciences

Date Written: June 3, 2010

Abstract

This paper examines how the interaction between inflation expectations and nominal and real macroeconomic variables has evolved for the United Kingdom over the post-WWII period until 2007. We model time-variation through a Markov-switching structural vector autoregressive framework with variants of the sign restriction identification scheme to back out the time-varying effect of different structural shocks. We investigate the following questions: (i) How has the impact of the mix of real and nominal shocks on the UK economy evolved over time and did this have a specific impact on UK inflation expectations? and (ii) Has there been an autonomous impact of inflation expectations on the UK economy and has it changed over time? Our results suggest that shocks to inflation expectations had important effects on actual inflation in the 1970s, but this impact had significantly declined towards the end of our sample. This seems to be mainly due to a relatively slower response of monetary policy to these shocks in the 1970s compared to later years. Similarly, oil price shocks and real demand shocks led to important changes in macroeconomic variables in the 1970s. Beyond that period and up to the end of our sample oil price shocks became less significant for the dynamics of actual inflation and output growth. However real demand shocks became a relatively more important determinant for fluctuations in those series during the 1990s and the beginning of the 2000s. The changing response of monetary policy to this type of shock appears to be crucial for this result.

Keywords: Inflation Expectations, Markov-Switching Structural VAR

JEL Classification: E5, C1

Suggested Citation

Barnett, Alina and Groen, Jan J. J. and Mumtaz, Haroon, Time-Varying Inflation Expectations and Economic Fluctuations in the United Kingdom: A Structural VAR Analysis (June 3, 2010). Bank of England Working Paper No. 392. Available at SSRN: https://ssrn.com/abstract=1619793 or http://dx.doi.org/10.2139/ssrn.1619793

Alina Barnett (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Jan J. J. Groen

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

HOME PAGE: http://nyfedeconomists.org/groen/

Haroon Mumtaz

University of London - School of Sciences ( email )

London, WC1E 7HX
United Kingdom

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