Sectoral Shocks and Monetary Policy in the United Kingdom

50 Pages Posted: 24 Apr 2014

See all articles by Huw David Dixon

Huw David Dixon

Cardiff University - Cardiff Business School

Jeremy Franklin

Bank of England

Stephen Millard

Bank of England

Date Written: April 17, 2014

Abstract

In this paper, we use an open economy model of the United Kingdom to examine the extent to which monetary policy should respond to movements in sectoral inflation rates. To do this we construct a Generalised Taylor model that takes specific account of the sectoral make up of the consumer price index (CPI), where the sectors are based on the COICOP classification the UK CPI microdata. We calibrate the model for each sector using the UK CPI microdata and model the sectoral shocks that drive sectoral inflation rates as white noise processes, as in the UK data. We find that a policy rule that allows for different responses to inflation in different sectors outperforms a rule which just targets aggregate CPI. However, the gain is small and comes from partially looking through movements in aggregate inflation driven by movements in petrol price inflation, which is volatile and tends not to reflect underlying inflationary pressure.

Keywords: CPI inflation, Sectoral inflation rates, Generalised Taylor economy

JEL Classification: E17, E31, E52

Suggested Citation

Dixon, Huw David and Franklin, Jeremy and Millard, Stephen, Sectoral Shocks and Monetary Policy in the United Kingdom (April 17, 2014). Bank of England Working Paper No. 499, Available at SSRN: https://ssrn.com/abstract=2428187 or http://dx.doi.org/10.2139/ssrn.2428187

Huw David Dixon

Cardiff University - Cardiff Business School ( email )

Aberconway Building
Colum Drive
Cardiff, CF10 3EU
United Kingdom

Jeremy Franklin

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Stephen Millard (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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