The Monetary Transmission Mechanism in The United Kingdom: Pass-Through & Policy Ru

Abstract

A number of recent papers have used policy simulations from small empirical macro models to assess the efficacy of inflation-forecast targeting. The macro models used to undertake the simulations differ significantly with the assumed degree of openness, an important factor for the analysis. However, the open economy models typically approach the pass-through from exchange rate to import prices and ultimately retail prices in a stylized manner, assuming full and instantaneous pass-through. This paper modifies the open economy macro model presented in Batini and Haldane (1999) to accommodate a variety of pass-through representations, considering time and state-(cycle)-dependent pass-through rules. While the model’s dynamics are affected, the main result of Batini and Haldane – that targeting an inflation forecast dominates targeting current inflation – is robust to the assumed rate of pass-through.