Monetary policy effectiveness in high vs low inflation environments: Evidence from the UK

The aim of this thesis is to assess the effectiveness of monetary policy actions in influencing the real economy when inflation is high. To this end, we compare the responses of various macroeconomic variables to a contractionary monetary policy shock in high and low inflation environments. The results of the empirical analysis are discussed in the light of state-dependent theories of price stickiness, which predict that prices are more responsive in a high inflation environment because firms have a greater incentive to change them, while the effects on output are dampened because of this heightened price flexibility. The research is motivated by the rise in inflation observed worldwide after the COVID-19 pandemic, which has forced policymakers to deal with an entirely new problem; high inflation is no longer a distant myth belonging to another era. Moreover, as this issue has recently been explored in some studies for the United States, we wanted to see if these results could be extended to another country. We therefore chose to analyse the United Kingdom, which is well suited to our purposes for a number of reasons, including monetary history, recent inflation trends and the monetary policy framework. The study employs threshold local projections to search for non-linearities in the impulse responses of output, inflation, short-term interest rates and unemployment. This research contributes to the monetary policy literature by providing some evidence of state-dependent behaviour of the economy for the UK.