Measuring Excess Demand and its Impact on Inflation.

Working paper

Inflation is fundamental to UK macroeconomic policy given that it is the sole target of monetary policy. However, there is no clear consensus on its determination, with a plethora of competing theories. Hendry (2001) argues that there is no single cause of inflation. This paper analyses quarterly UK inflation from 1966-2002 based on this premise. The use of a general to specific framework in which all extant theories of inflation are captured in the general unrestricted model ensures that there are no a priori restrictions on the possible determinants of inflation. Excess demand pressures play a fundamental role in the determination of inflation but they are notoriously difficult to measure and hence a detailed derivation of the output gap is undertaken as a central explanatory variable. We derive a dominant congruent model of inflation within a single equation dynamic framework that encompasses all relevant theories and is a good representation of the data.

Authors: Castle, J

• Publisher: Department of Economics (University of Oxford)
• Publication date: 2004-01-01
• Language: English