Nonlinear Interest Rate Reaction Functions for the UK

Ralf Brüggemann and Jana Riedel

No 2010-15, Working Paper Series of the Department of Economics, University of Konstanz from Department of Economics, University of Konstanz

Abstract: We empirically analyze Taylor-type equations for short-term interest rates in the United Kingdom using quarterly data from 1970Q1 to 2006Q2. Starting from strong evidence against a simple linear Taylor rule, we model nonlinearities using logistic smooth transition regression (LSTR) models. The LSTR models with time-varying parameters consistently track actual interest rate movements better than a linear model with constant parameters. Our preferred LSTR model uses lagged interest rates as a transition variable and suggests that in times of recessions the Bank of England puts more weight on the output gap and less so on inflation. A reverse pattern is observed in non-recession periods. Parameters of the model change less frequently after 1992, when an inflation target range was announced. We conclude that for the analysis of historical monetary policy, the LSTR approach is a viable alternative to linear reaction functions.

Keywords: interest rate reaction functions; smooth transition regression model; monetary policy (search for similar items in EconPapers)
JEL-codes: C51 C53 E43 E52 E58 (search for similar items in EconPapers)
Pages: 24 pages
Date: 2010-12-03
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Citations: View citations in EconPapers (5)

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Journal Article: Nonlinear interest rate reaction functions for the UK (2011)
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