Has monetary policy reacted to asset price movements? Evidence from the UK

Abstract

This paper examines the relationship between monetary policy and asset prices in the context of empirical policy rules. We begin our analysis by establishing the forecasting ability of house and stock price changes with respect to future aggregate demand. We then report estimates of monetary policy reaction functions for the United Kingdom over the period 1992-2003. We find that UK policymakers appear to take into account the effect of asset price inflation when setting interest rates with a higher weight being assigned to property market fluctuations. Asset inflationaugmented rules describe more accurately actual policy, and the results are robust to modelling the effect of the Bank of England independence.