Financial Stability and Monetary Policy

Abstract

We argue that although UK monetary policy can be described using a Taylor rule in 1992-2007, this rule fails during the recent financial crisis. We interpret this as reflecting a change in policymakers’ preferences to give priority to stabilising the financial system. Developing a model of optimal monetary policy with preference shifts, we show this provides a superior empirical model over crisis and pre-crisis periods. We find no response of interest rates to inflation during the financial crisis, possibly implying that the UK abandoned inflation targeting during the financial crisis.monetary policy, financial crisis