Inflation Targeting in the United Kingdom: Is there evidence for Asymmetric Preferences?

Pranjal Rawat and Naveen Srinivasan

Working Papers from Madras School of Economics,Chennai,India

Abstract: In recent times, inflation targeting has been one of the most successful monetary frameworks in advanced economics. However, critics claim that policy rates have been kept higher than necessary. They claim that central banks did not pursue a symmetric inflation target. If a central bank pursues symmetric inflation and output targets, the optimal monetary policy response is a linear forward-looking Taylor rule (Clarida et,. al 1999). We use the Linex Loss function as outlined in Nobay and Peel (2003) to relax the assumption of symmetric preferences. The presence of asymmetric preferences implies that monetary policy reacts not only to the conditional expectation of inflation and output gap but also to their conditional variances. Non-linear Taylor rules are estimated on UK data from 1995: Q2 and 2003: Q3. The results support the critics. Inflation targeting was indeed pursued with asymmetric preferences. The findings are robust to the Bank of England’s ex-ante forecasts, ‘real-time’ estimates of the output gap, non-linearities in the supply curve, and alternative forecast horizons. Policy rates have been about 30 basis points higher than necessary due to asymmetric preferences.

Keywords: Phillips curve; Taylor Rules; Asymmetric Preferences; Deflationary Bias; GMM estimation; Linex Loss Function; Rational Expectations; Monetary Policy (search for similar items in EconPapers)
JEL-codes: E31 E52 E6 (search for similar items in EconPapers)
Pages: 46 pages
Date: 2020-06
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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