Luca Benati

Evolving Post-World War II UK Economic Performance

This paper uses tests for multiple structural breaks at unknown points in the sample period, and band-pass filtering techniques, to investigate changes in UK economic performance since the end of World War II. Empirical evidence suggests that the most recent decade, associated with the introduction of an inflation-targeting regime, has been significantly more stable than the previous post-WWII era. For real GDP growth, and for three measures of inflation, break dates are identified at around the time of the introduction of inflation-targeting, in October 1992. For all four series, the estimated innovation variance over the most recent subperiod has been the lowest of the post-WWII era. The volatility of the band-pass filtered macroeconomic indicators considered has been, after 1992, almost always lower than either during the Bretton Woods regime or the 1971-92 period; often, as in the cases of inflation and real GDP, markedly so. The Phillips correlation appears to have undergone significant changes over the past 50 years, from being unstable in the 1970s, to slowly stabilising from the beginning of the 1980s onwards. After 1992, the correlation has exhibited by far the greatest degree of stability during the post-WWII era.

UK Monetary Regimes and Macroeconomic Stylised Facts

We exploit the marked changes in UK monetary arrangements since the metallic standards era to investigate continuity and changes across monetary regimes in key macroeconomic stylised facts in the United Kingdom. We find that, historically, inflation persistence has been the exception, rather than the rule, with inflation estimated to have been highly persistent only during the period between the floating of the pound, in June 1972, and the introduction of inflation targeting, in October 1992. As a corollary, our results clearly reject Mishkins explanation for time variation in the extent of the Fisher effect, favouring instead Barskys theory. We document a remarkable stability across regimes in the correlation between inflation and the rates of growth of both narrow and broad monetary aggregates at the very low frequencies, thus countering the Whiteman-McCallum criticism of Lucas. The post-1992 inflation-targeting regime appears to have been characterised, to date, by the most stable macroeconomic environment in recorded UK history, with the volatilities of the business-cycle components of real GDP, national accounts aggregates, and inflation measures having been, post-1992, systematically lower than for any of the pre-1992 monetary regimes/historical periods, often markedly so, as in the case of inflation and real GDP. The Phillips correlation between inflation and unemployment was flattest under the gold standard, steepest between 1972 and 1992. In line with Ball, Mankiw and Romer, evidence points towards a positive correlation between mean inflation and the steepness of the trade-off. We show how Keynes, in his dispute with Dunlop and Tarshis on real wage cyclicality, was entirely right: during the inter-war period, real wages were strikingly countercyclical. By contrast, under inflation targeting they have been, so far, strongly procyclical.

Band-Pass Filtering, Cointegration, and Business Cycle Analysis

This paper critically assesses the practice of band-pass filtering (the non-structural, frequency-domain based decomposition of economic time series into trend and cyclical components), making two main points. First, it is shown that: (a) depending on the stochastic properties of the filtered process, the band-pass filtered cyclical component is entirely authentic, partly or mostly spurious, or even entirely spurious; and (b) as a simple consequence of the Lucas critique, the degree of authenticity of band-pass filtered cyclical components crucially depends on the monetary rule followed by the policy-maker. Second, taking a number of macroeconomic models as data-generation processes it is shown that band-pass filtering: (a) may markedly distort key business cycle stylised facts, as captured by the cross-correlations and the cross-spectral statistics between the cyclical components of the variables of interest and the cyclical component of GDP; and (b) may well create entirely spurious stylised facts. For example: both productivity and the money supply may appear procyclical even when they follow random walks by construction; the real wage may appear procyclical when in fact it is countercyclical; in general, the Phillips correlation between inflation and the cyclical component of economic activity will appear weaker than it is in reality. Again, the degree of authenticity of business cycle stylised facts uncovered via band-pass filtering crucially depends on the monetary rule followed by the policy-maker.