Effectiveness of Interest Rate Policy on The Management of
Macroeconomic Stability: Evidence from the United Kingdom
Mostafa E. AboElsoud*, Anas AlQudah**, Dimitrios Paparas**
Suez Canal University, Ismailia, Egypt*
The British University in Egypt, Cairo, Egypt*
Yarmouk University, Jordan**
Harper Adams University, U.K.***
Abstract: This study examines the dynamic relationship between the London Interbank Offered Rate (LIBOR), the inflation rate, the unemployment rate and economic growth in the context of the UK, for the period 1992: Q1 to 2016: Q4. The study aims to evaluate the impact of the LIBOR on the management of macroeconomic stability in the UK during the period under review. The study employs a vector autoregressive (VAR) model to examine the dynamic relationship between interest rates, unemployment and GDP. A co-integration test evaluates the long-run relationship between these variables, and the VAR Granger-causality tests the direction of causation among the variables.
The Augmented Dickey-Fuller test shows that the co-integration conditions are not satisfied, as they do not confirm the existence of a long-run relationship between the LIBOR and the other variables. However, the VAR model indicates that there does exist a dynamic short-run relationship between the LIBOR and the consumer price index (CPI) as a measure of inflation. In contrast, the model suggests that there no short-run relationship exists between either the LIBOR and unemployment rate or the LIBOR and economic growth. Granger-causality Wald tests suggest that there is a directional causality between the LIBOR and the inflation rate. However, the test does not indicate a directional causality between the LIBOR and the other variables, suggesting that the former does not contribute to employment or economic growth in the UK.
The findings suggest that while the LIBOR is sufficient for controlling inflation, it is not sufficient for improving economic growth and employment in the UK. Additionally, the study supports the likelihood of the Bank of England using monetary policy instruments that are alternatives to the LIBOR to boost economic growth in the UK.
JEL Classification: E43, E52, E58
Keywords: London Interbank Offered Rate, interest rate, monetary policy, macroeconomic goals, UK