Competitiveness, Inflation, and Monetary Policy

34 Pages Posted: 19 May 2005  

Hashmat Khan

Bank of England - Structural Economic Analysis Division

Richhild Moessner

De Nederlandsche Bank

Date Written: January 2005

Abstract

This paper examines the way in which structural changes in the level of steady-state competitiveness and the trend rate of inflation affect inflation responses to monetary policy shocks, in scenarios chosen to capture broadly the conditions of the UK economy in the early 1990s and more recently. Cyclical changes in competitiveness are also considered, since it is not clear empirically whether changes in competitiveness have been predominantly structural or cyclical. A model based on work by Woodford is used, allowing for positive trend inflation and cyclical variations in competitiveness in a tractable manner. This extension enables the separate quantification of the impact of differences in the steady-state level of and cyclical changes in competitiveness on inflation in the short term, in high and low inflation environments. The paper quantifies the extent to which procyclical (countercyclical) changes in competitiveness dampen (amplify) the impulse responses of inflation to a given monetary policy shock. In the calibration used, the inflation response to monetary policy shocks in a low inflation/high competitiveness environment is dampened compared with a high inflation/low competitiveness environment. By contrast, inflation responses to monetary policy shocks in a low inflation/low competitiveness environment are similar to those in a high inflation/high competitiveness environment.

Keywords: Competitiveness, trend inflation, structural change

JEL Classification: E31, E32

Suggested Citation

Khan, Hashmat and Moessner, Richhild, Competitiveness, Inflation, and Monetary Policy (January 2005). Bank of England Working Paper Series No. 246. Available at SSRN: https://ssrn.com/abstract=723901 or http://dx.doi.org/10.2139/ssrn.723901

Hashmat Khan (Contact Author)

Bank of England - Structural Economic Analysis Division ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Richhild Moessner

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

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