UK Monetary Policy 1972-97: A Guide Using Taylor Rules

In the period from the floating of the exchange rate in 1972 to the granting of independence to the Bank of England in 1997, UK monetary policy went through several regimes, including: the early 1970s, when monetary policy was subordinate to incomes policy as the primary weapon against inflation; Sterling M3 targeting in the late 1970s and early 1980s; moves in the late 1980s toward greater exchange rate management, culminating in the UK’s membership of the ERM from 1990-92; and inflation targeting from October 1992. This Paper estimates simple interest rate reaction functions, or ‘Taylor rules’, for different UK monetary policy regimes. The inflation targeting regime that began in 1992 appears to be the only period that is characterized by the ‘Taylor principle’, namely a greater than one-for-one response of interest rates to fluctuations in inflation. In contrast to the US case, the early 1980s disinflation in the UK appears best characterized as an increase in the intercept of the authorities’ interest rate rule rather than by an increased systematic response of monetary policy to inflation.