The United Kingdom's Experience with Inflation Targeting

IMF Working Papers, June 1, 1998

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Reviews the first five years’ experience with inflation targeting in the United Kingdom.
Concludes that inflation performance was not significantly different under inflation targeting than predicted by a VAR model estimated in the period prior to participation in the exchange rate mechanism (ERM).
Finds that both short- and long-term interest rates were lower than predicted, consistent with the interpretation that some gains in credibility were achieved under the inflation targeting regime.

Inflation performance comparison:
- Inflation performance under inflation targeting was not significantly different from predictions of a VAR model estimated for the pre-ERM period.
Interest rate outcomes:
- Both short-term interest rates and long-term interest rates were lower than predicted by the VAR model.
- The lower-than-predicted interest rates are interpreted as evidence of some gains in credibility under the inflation-targeting regime.

Empirical approach:
- Uses a Vector Autoregression (VAR) model estimated in the period prior to participation in the ERM to generate predicted paths for inflation and interest rates.
- Compares actual outcomes during the first five years of inflation targeting to the VAR-predicted outcomes.

Subject: Econometric analysis, Financial services, Inflation, Inflation targeting, Long term interest rates, Monetary policy, Prices, Short term interest rates, Vector autoregression
Keywords: Australia and New Zealand, boosts credibility, ERM, Global, Inflation, inflation performance, inflation targeting, inflation targeting entail, inflation targeting experience, inflation targeting period, inflation-targeting framework, interest rate, Long term interest rates, monetary framework, monetary policy, Short term interest rates, surprise inflation, United Kingdom, Vector autoregression, WP