Bank of England (BoE), as an independent organization stimulates the economic growth, by maintaining the transparency of the monetary policies conducted and regulates financial and foreign markets. In this report, I studied the relativity of monetary policy led by the central bank to the economic growth achieved during 1990-2011 in the UK and the effectiveness of the transmission mechanism through the channels involved. I concluded that it [monetary policy] had a direct impact on price stability using the intermediate targets such as monetary aggregates and official rates and, thereby influenced on the short term money market rates, firm and individuals’ saving behaviors and total unemployment level in the specified periods. Further, I ran a vector autoregression (VAR) function over annual gross domestic product and broad money (M3) within the time range specified and found three-lagged-order optimal for the applied model. The 3 year long recession in the early phase of 1990, the dismissal of the UK from Exchange Rate Mechanism (ERM) (1992-7), the invasions into Afghanistan (2001) and Iraq (2003), the first appearance of credit crunch (2008-9) were reflected in impulse response function (IRF). Also, Granger causality test resulted in money as being an endogenous factor and I explained it with that that the granger’s test rather examines which phenomenon occurs first in a statistical viewpoint, than the real causality between series. The results of Lagrange Multiplier test for serial correlation in the residuals and joint significance test of coefficients were all positive at the selected lag-order and the model eigenvalues lied inside the circle. I also provided the forecasted values -generated by Stata software package- to money stock, GDP and interest rate and the values proved accurate only in a year time.
Keywords: Quantitative easing, Vector autoregression (VAR), Granger causality test, Impulse response function, Transmission Mechanism.
Table of Contents
1. Abstract
2. Introduction
3. Literature Review
4. Transmission Mechanism
5. Data Source and Description
6. Modeling
6.1 Vector Autoregression (VAR)
6.2 Impulse Response Function (IRF)
6.3 Lagrange Multiplier Test for Autocorrelations
6.4 Joint Significance Test of the VAR Coefficients
6.5 Granger Causality
7. Regression Results
8. Concluding Remarks
Objectives and Topics
This report aims to analyze the implications of the Bank of England's monetary policy between 1990 and 2011, focusing on its effectiveness in stabilizing price levels and influencing economic growth through various transmission channels.
- Analysis of the monetary transmission mechanism in the UK.
- Evaluation of the impact of monetary policy on GDP, money stock, and interest rates.
- Application of Vector Autoregression (VAR) modeling to test economic variables.
- Investigation of causality between macroeconomic factors using the Granger Causality test.
Excerpt from the Book
Transmission Mechanism
Transmission mechanism means the process or the processes of how the monetary policy affects the economy and increases the output growth. It goes by four main channels (Mishkin, 2006), and each will be separately described in the paragraphs below.
Interest rate. Bank of England affects the aggregate demand and influences the borrowing and spending behavior. Here is how. First, it lends largely through constraint maturity gilt sales and repurchases agreements (repo) (Bank of England). The repo rate (official rate) is responded by the market rates as the rates are assumed to be valid for a foreseeable near future. For example the expansionary monetary policy, with the decreased repo rate lowers money-market rates and other short-term rates. The decreased rates stimulate borrowing, since the cost of borrowing now is cheaper and lessens the savings. The borrowed money will be spent in a number of investments and consumption of various products, thus results in an increase in aggregate demand. However, the decreased interest rate favors domestic investment, which implicitly pushes net exports down; and increased interest rates could possibly increase consumption of savers. Therefore, the bank scrutinizes the total consumption behavior and acts upon it.
Exchange rate channel. Bank of England buys back its own currencies by selling the foreign assets, including foreign currency reserves to gain appreciation or sells its own currency to gain depreciation (the latter is also called sterilization). By changing the store value of its currency, Bank of England influences on the price indirectly. The chain of effect is following; first, suppose Bank of England sets the official interest rates, thereby shifts the savings function. The change in savings consequently effects on the net capital outflow, which further changes the exchange rate.
Summary of Chapters
Abstract: Provides a high-level overview of the research, summarizing the study on the Bank of England's monetary policy effectiveness and the methodology used for the analysis.
Introduction: Outlines the primary goal of the central bank and describes the four main channels through which monetary policy affects the economy.
Literature Review: Discusses historical economic trends in the UK from the post-Thatcher era through 2011, including recessions and policy shifts.
Transmission Mechanism: Details the specific processes by which monetary policy impacts economic growth, including interest rate, exchange rate, credit, and asset pricing channels.
Data Source and Description: Describes the economic indicators used for the research and the statistical sources obtained from the OECD database.
Modeling: Explains the quantitative approach, specifically the Vector Autoregression (VAR) model and associated tests for stability, correlation, and causality.
Regression Results: Presents the statistical outcomes derived from the VAR analysis, including coefficients and impulse response functions.
Concluding Remarks: Summarizes the findings regarding the challenges of evaluating monetary policy and provides expectations for future economic variables.
Keywords
Monetary policy, Bank of England, Quantitative easing, Vector autoregression, VAR, Granger causality test, Impulse response function, Transmission Mechanism, GDP, Interest rates, Price stability, Economic growth, Money supply, Recession, UK economy.
Frequently Asked Questions
What is the core focus of this research?
The report examines the implications of the Bank of England's monetary policy on UK economic growth and price stability between 1990 and 2011.
What are the primary thematic areas covered?
The study focuses on the transmission mechanism of monetary policy, the impact of central bank actions on macro-economic variables, and the quantitative modeling of these relationships.
What is the main research objective?
The primary objective is to determine the relativity of monetary policy led by the Bank of England to achieved economic growth and to assess the effectiveness of the channels involved.
Which scientific methods are applied?
The paper utilizes Vector Autoregression (VAR) models, Impulse Response Functions (IRF), Lagrange Multiplier tests for autocorrelation, and Granger Causality tests.
What topics are discussed in the main body of the work?
The main body covers the transmission channels (interest rate, exchange rate, credit, asset pricing), historical economic context, data sources, and the results of the statistical modeling.
Which keywords characterize this work?
Key terms include Quantitative easing, Vector autoregression (VAR), Granger causality test, Impulse response function, and Transmission Mechanism.
How does the author evaluate the "Transmission Mechanism"?
The author breaks it down into four distinct channels: the interest rate channel, the exchange rate channel, the credit channel, and the asset pricing channel.
What was a key finding regarding the Granger Causality test?
The test suggested that money behaves as an endogenous factor, and the author notes that the test identifies statistical priority rather than true economic causality.
Why is the "Vector Autoregression" (VAR) model used?
The VAR model is used as a multivariate method to model time series, allowing the author to identify the interrelationships between GDP, money stock, and interest rates over the specified period.
- Quote paper
- Nosirjon Juraev (Author), 2013, The Implications of UK Monetary Policy (1990-2012), Munich, GRIN Verlag, https://www.hausarbeiten.de/document/266932
