Abstract:
In this paper, we estimate a Small Open Economy Dynamic Stochastic General Equilibrium
(SOEDSGE) model of the United Kingdom (UK), with the main focus being to test the hypothesis
whether the Bank of England (BoE) responds to (frequency-dependent) exchange rate movements
or not. For our purpose, we use an extended quarterly data set spanning the period of 1986:Q2 to
2018:Q1, which in turn includes the zero lower bound situation, and also estimate the SOEDSGE
model based on observable data decomposed into its frequency components. We find that the BoE
not only responds to exchange rate movements in a statistically significant manner, but also that
it primarily focuses on long-term movements of currency depreciations more strongly than shortterm
fluctuations of the same. In general, our results are also confirmed for three other developed
inflation-targeters namely, Australia, Canada and New Zealand.
