The macroeconomic effects of monetary policy: A new measure for the United Kingdom

This paper estimates the effects of monetary policy on the UK economy based on a new, extensive real-time forecast data set. Employing the Romer Romer identification approach we first construct a new measure of monetary policy innovations for the UK economy. We find that a one percentage point increase in the policy rate reduces output by up to 0.6 per cent and inflation by up to 1.0 percentage point after two to three years. Our approach resolves the price puzzle for the UK and we show that forecasts are crucial for this result. Finally, we show that the response of policy after the initial innovation is crucial for interpreting estimates of the effect of monetary policy. We can then reconcile differences across empirical specifications, with the wider VAR literature and between our UK results and the larger narrative estimates for the US.