Monetary Policy Preferences of the European Monetary Union and the UK

Philip Arestis, Michail Karouglou and Kostas Mouratidis

No 2011019, Working Papers from The University of Sheffield, Department of Economics

Abstract: This paper estimates central bank policy preferences in the case of the European Monetary Union and of the UK. We do so, by adopting the framework suggested by Cecchetti and Ehrmann (1999), which, however, we extent in two respects. First, we allow policy preferences to be asymmetric by assuming that inflation and output follow a Markov process. Second, following Bean (1998) we introduce dynamics in the supply and demand relationships. In doing so we estimate state-dependent policy frontiers. Empirical results from the static model show that monetary policy in the European Monetary Union and in the UK put a lot of weight on price stability. However, there is evidence of 'price puzzle' especially in the high volatility regime. The price puzzle might be the by-product of frequent realignments in the European Monetary System currency crises in 1992, 1993 and 1995 and of the more recent 2008 financial crisis. Estimates of the optimal policy frontier suggest that although the UK enjoys higher anti-inflatonary credibility, it also faces a higher trade-off between inflation and output variability than the European Monetary Union.

Pages: 26 pages
Date: 2011-09
New Economics Papers: this item is included in nep-cba, nep-eec, nep-mac, nep-mon and nep-pke
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Persistent link: https://EconPapers.repec.org/RePEc:shf:wpaper:2011019

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