Financial stabilisation and interest rate modelling in the United Kingdom

Abstract

This study models and explains the movement of the short-term interest rate in the United Kingdom (UK) using statistical models building on economic theories. It investigates three main areas and makes a number of contributions to the existing monetary policy literature in the UK. First, it investigates alternative methods to construct financial conditions indices (FCIs) and creates an optimal FCI for the UK. The estimated optimal FCI is the one that best predicts economic activity in the UK. Second, this is the first study in the literature to test the existence of a short-term inflation target for an inflation-targeting central bank like the Bank of England (BOE). Third, this study investigates the most appropriate methodology for modelling the short-term interest rate in the UK using new data and a new estimator.