The New UK Monetary Arrangements: A View From the Literature

Charles Richard Bean

146 citations0/0 files storedThe Economic Journal

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Monetary Policy and Economic Impact Economic theories and models European Monetary and Fiscal Policies

Abstract

This paper considers the likely operating characteristics of the new UK monetary arrangements introduced in May 1997. The paper first argues that the time inconsistency of policy is not an issue provided the Bank of England is properly independent. However, the current inflation remit from the Chancellor to the Bank specifies a numerical target for the inflation rate, but does not specify how quickly deviations from the target are to be corrected. It is thus an incomplete contract, and there is a danger that the Bank may choose to stabilise inflation at the cost of excessively volatile movements in output, or vice versa. We estimate the optimal policy frontier for the UK economy and show that in practice it is close to rectangular. Consequently all the Bank needs to assume is that the government's preferences are ‘reasonable’ in order to know approximately where to locate on this frontier; the incompleteness of the remit therefore need not be a cause for concern.

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References

1985The Optimal Degree of Commitment to an Intermediate Monetary Target 1981A Positive Theory of Monetary Policy in a Natural-Rate Model 1993Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence 1997Inflation forecast targeting: Implementing and monitoring inflation targets 1991Political and Monetary Institutions and Public Financial Policies in the Industrial Countries 1992Central Bank Strategy, Credibility, and Independence: Theory and Evidence 1996The Macroeconomics of Low Inflation 1995Optimal contracts for central bankers

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