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Real and nominal UK interest rates, ERM membership, and inflation targeting

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  • Andreas Reschreiter

Abstract

This paper models the time-varying mean of the UK real and nominal short-term interest rate. Both rates mean revert to a time-varying central tendency in continuous-time interest rate models. Before and during British membership in the ERM, the mean of the real and nominal short rate have a strong negative correlation. Afterwards, when the UK implemented an inflation targeting policy, the mean of the real and nominal short rate are no longer negatively correlated, but instead have a strong positive correlation. The paper also reports empirical evidence of a relationship between the mean of the real and nominal short rate and inflation in the period before the departure from the ERM.
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Suggested Citation

  • Andreas Reschreiter, 2011. "Real and nominal UK interest rates, ERM membership, and inflation targeting," Empirical Economics, Springer, vol. 40(3), pages 559-579, May.
    • Handle: RePEc:spr:empeco:v:40:y:2011:i:3:p:559-579
    DOI: 10.1007/s00181-010-0345-z
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    More about this item

    Keywords

    Nominal and real rates; ERM; Inflation targeting; Term structure model; UK; E42; E43; E52; F33; G12;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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