The Macroeconomic Effects of Monetary Policy: A New Measure for the United Kingdom

Abstract

This paper estimates the effects of monetary policy on the UK economy based on a new, extensive real-time forecast data set. Employing the Romer–Romer identification approach we first construct a new measure of monetary policy innovations for the UK economy. We find that a 1 percentage point increase in the policy rate reduces output by up to 0.6% and inflation by up to 1.0 percentage point after two to three years. Our approach resolves the price puzzle for the United Kingdom and we show that forecasts are crucial for this result. Finally, we show that the response of policy after the initial innovation is crucial for interpreting estimates of the effect of monetary policy. We can then reconcile differences across empirical specifications, with the wider vector autoregression literature and between our United Kingdom results and the larger narrative estimates for the United States.

Keywords: Monetary policy, narrative identification, real-time forecasts, business cycles

JEL Classification: E31, E32, E52, E58