Base Money Rules in the UK

Abstract

This paper assesses the performance of a simple monetary policy rule - McCallum's rule. This rule targets nominal income using the monetary base as its instrument whilst making an allowance for any on-going changes in money velocity. The paper conducts a range of historical counterfactual simulation exercises to establish the likely impact on the UK economy of using such a rule over the period 1960 to 1994. The paper finds that had the rule been followed over that period a far superior inflationary performance would have resulted. Moreover, this improved performance would not have come about at the expense of heightened output or base money variability. The paper suggests that while such a rule could never substitute a more eclectic approach which uses a wider range of indicators, it could serve as a useful benchmark when assessing whether monetary policy is broadly "on track"; it is a effectively a dynamic M0 monitoring range. As such, the implied profiles from such a simple rule may help provide insurance against the type of "big" policy mistakes which the UK economy has been subject to over the last 25 years.