The University of Hull ‘Regional Macroeconomic Dynamics in Britain: Investigating structural heterogeneity in transmission of shocks’ being a thesis submitted for the Degree of Doctor of Philosophy in the University of Hull by Andrew Stephen Sloan (BEng, MSc) January, 2009 Table of Contents Table of contents ...................................................................................................i List of figures ....................................................................................................... iii List of tables........................................................................................................viii Acknowledgement................................................................................................ xi Acknowledgement................................................................................................ xi Dedication........................................................................................................... xii Preface ...............................................................................................................xiii List of abbreviations ........................................................................................... xix Part I 1 Introduction ........................................................................................................1 2 A description of the UK regional economies ....................................................21 3 Discussion of data used and issues.................................................................47 Part II 4 Research review ..............................................................................................57 4.1 Structural VARs (‘SVARs’) ........................................................................58 4.1.1 SVARs a short technical introduction .....................................................59 4.1.2 SVARs, a literature review.....................................................................63 4.2 Research review: the use of VARs in monetary policy analysis ................78 4.3 Research review: regional monetary transmission ...................................86 4.4 Research review: the UK regions .............................................................98 5 Effects of demand and supply shocks on the UK regions ..............................112 5.1 Covers' identification ...............................................................................114 5.2 Data.........................................................................................................119 5.3 Results from the Blanchard Quah decomposition ..................................122 5.4 Covers' results.........................................................................................133 5.5 Constructing demand and supply curves from cumulative responses.....159 6 Monetary VARs for the UK regions................................................................167 6.1 Methodological issues .............................................................................170 6.2 Data.........................................................................................................176 6.3 Responses ..............................................................................................180 6.4 Comparison of sets of responses ............................................................189 6.5 Explanatory variables ..............................................................................201 6.6 Robustness checks .................................................................................211 6.7 Regional sectors......................................................................................220 6. 8 Conclusion..............................................................................................228 Part III 7 NKPC theory and research review.................................................................231 7.1 History of the Phillips curve (inflation/output dynamics) ..........................233 7.2 The New Keynesian Phillips curve ..........................................................240 7.3 Estimating the NKPC, method.................................................................252 7.5 Estimating the NKPC, research Review ..................................................255 8 Estimated Phillips curves: New Keynesian (hybrid) and traditional for the UK regions ..............................................................................................................263 8.1 Data........................................................................................................264 8.2 NKPC estimates ......................................................................................270 8.3 NKPC empirical methodology.................................................................274 8.4 Testing the NKPC model.........................................................................276 8.5 NKPC formal results................................................................................282 8.6 Accounting for differences in regional NKPCs.........................................289 8.7 Bootstrapping ..........................................................................................296 8.8 Welfare losses.........................................................................................297 8.9 Wage Phillips curves ...............................................................................301 8.10 Conclusion.............................................................................................310 Part IV 9 Summary, Contribution & Conclusions ..........................................................312 9.1 Summary.................................................................................................313 9.2 Contribution.............................................................................................318 9.3 Conclusions.............................................................................................323 References .......................................................................................................327 Appendix 1: Industrial decompostion of fegions (EM, EA, SE, SW, WM, NW, Wal, Sco) ..........................................................................................................357 Appendix 2: Solving for output and price level .................................................365 Appendix 3: Co-integration tests (chapter 5)....................................................366 Appendix 4: Unit root tests (chapter 5).............................................................367 Appendix 5: Lag length tests (chapter 5) .........................................................369 Appendix 6: BQ & Cover decompostions: rest of regions ................................370 Appendix 7: Covers' parameter tables: rest of regions ....................................398 Appendix 8: Vardecompositons, rest of regions...............................................403 Appendix 9 Co-integration test (chapter 6): ......................................................408 Appendix 10: Unit root test (chapter 6) ............................................................408 Appendix 11: VAR in levels: stability tests (Eviews output)..............................409 Appendix 12: VARs, regional sectors...............................................................412 Appendix 13: NKPC estimate using output gap ...............................................419 Appendix 14: Fits of inflation vs alternative models, rest of regions.................420 Appendix 15: Bootstrapping omega: estimate distributions .............................425 Appendix 16: RATS algorithm: Covers decomposition ....................................430 ii List of Figures Figure 1: Illustrating how a common shock can have a level effect .....................4 Figure 2: The Monetary Policy Committee’s view of the monetary transmission mechanism (source, BoE (2006)) .........................................................................6 Figure 3: Population shares of the UK regions ..................................................24 Figure 4: Regional GVA/head (indexed basis, UK average = 100) ....................25 Figure 5: Regional GVA, 1989 – 2006 (1990 Prices).........................................26 Figure 6: Average GVA growth rates (%), 1989 – 2006, UK regions .................27 Figure 7: Industrial composition of NE, 1982 .....................................................28 Figure 8: Industrial composition of NE, 2002 .....................................................28 Figure 9: Industrial composition Yks, 1982 ........................................................29 Figure 10: Industrial composition Yks, 2002 ......................................................29 Figure 11: Industrial composition Ldn, 1982 ......................................................30 Figure 12: Industrial composition Ldn, 2002 ......................................................30 Figure 13: NE growth (by sector) 1982 – 2002 (1990 prices, £bns)...................31 Figure 14: Yks growth (by sector) 1982 – 2002 (1990 prices, £bns)..................31 Figure 15: Ldn growth (by sector) 1982 – 2002 (1990 prices, £bns)..................32 Figure 16: Oxford Economics/NIESR Regional Model, modeling framework.....33 Figure 17: UK regions, average sectoral growth rates 1982 – 2002 ..................35 Figure 18: UK regions, unemployment rates (%) 1982 – 2004 ...........................36 Figure