The informational content of empirical measures of real interest rate and output gaps for the United Kingdom
By: by Jens D. J. Larsen and Jack McKeown.
Contributors: McKeown, Jack, 1977-; Bank of England.
Series: Working paper,; no. 224; Working paper (Bank of England : Online) ;; no.224.
Publisher: Bank of England
Published: 2004
Place of publication: London
Language: eng
Format: Electronic resource
Subjects: Interest rates -- Great Britain.
Description: "In many economies, the monetary policy instrument is the level of short-term nominal interest rates, but the monetary policy stance might be better characterised by the ex-ante real interest rate that this nominal rate implies, relative to some 'neutral' or 'natural' real rate of interest. In this paper, the natural rate of interest and the real interest rate gap - the difference between the actual and the natural real rate of interest - are estimated by applying Kalman filtering techniques to a small-scale macroeconomic model of the UK economy. In this model, the real interest rate gap, the output gap and inflation are related via IS-curve and Phillips-curve relationships. The natural rate of interest is defined as the level of (ex-ante) real interest rates that is consistent with an output gap of zero, that is output at its natural level, in the medium term. Based on these estimates, the paper examines whether empirical measures of the real interest rate gap are a useful tool for policymakers - do they contain additional information relative to the estimated output gap, and does the real rate gap have leading indicator properties for the output gap and inflation? Are these gap estimates of practical use in a policy setting? The paper finds that the real rate gap has leading indicator properties for both the output gap and inflation. Importantly, these properties have varied considerably over time: breaking the sample into four subsamples, it appears that the leading indicator properties for both the output and real rate gap were substantially stronger for the subsample that covers most of the 1980s. After the introduction of the inflation target, post 1992, the relationship between the real interest rate gap and the output gap strengthens, but the leading indicator properties of these gaps for inflation diminish, as might be expected under an inflation-targeting regime"--Bank of England web site.
Notes: Includes bibliographical references.
Title from PDF file as viewed on 4/12/2005.
Also available in print.
System requirements: Adobe Acrobat Reader.
Mode of access: World Wide Web.