True or False?
As can be seen by examining the Excel spreadsheet file gdpshare.xls, Great Britain's share of the total output of the major industrial countries in the year 2000 was around 6 percent. This compares with Canada's share which was about 3.5 percent. The share of the United States, at nearly 42 percent, was was the highest of all countries examined. The countries in the Euro Area in the year 2000 had together a share of nearly 30 percent. The shares of the above countries in total world output are, of course, considerably smaller when we include China and India in that total, along with the myriad of small countries not included in the Excel spreadsheet.
Consider now an expansionary monetary policy by the United States sufficient to lower domestic interest rates in a closed economy situation by, say, 2 percentage points. The level of world interest rates, and correspondingly the actual interest rates in the United States, will fall by less than 1 percent, given that country's share in the world economy. Of course, if other countries also expand their money supplies to keep their exchange rates from appreciating with respect to the U.S. dollar, the world money supply will expand sufficiently to force world interest rates down further because the world is a closed economy. Regardless of the response of other countries, it makes sense for the U.S. to use domestic interest rates, particularly the federal funds rate, as an indicator of the stance of monetary policy, as long as a Taylor Rule calculation confirms that observed interest rates are being appropriately divided into their real and expected inflation components.
Since, at least among the major industrial countries, there is a world capital market, real interest rate differentials should reflect risk differentials and be little influenced by the stance of U.S. monetary policy. The magnitudes of changes in the world demand for U.S. relative to foreign securities associated with on-going changes in base money in the United States should typically be tiny fractions of world portfolios, although these effects would certainly be larger than the effects of normal base money changes in smaller countries like Canada. In other words, the U.S. is big enough for its monetary policy to affect the level of world real interest rates but not real interest rate differentials across countries.
Now the United Kingdom is somewhat less than twice as large as Canada. A monetary expansion in that country will thus have a trivial effect on the level of world real interest rates and an equally trivial effect on U.K./U.S. real interest rate differentials---as in the case of Canada, the magnitudes of changes in the demand for British capital assets resulting from normal base money changes in the U.K. would surely be a tiny fraction of rest-of-world holdings of those securities. So it makes no sense for the Bank of England to conduct its monetary policy with reference to a Taylor Rule.
As indicated by the standard Fleming-Mundell result, monetary policy in the United Kingdom will operate on the economy through its effects on that country's nominal and real exchange rates with respect to the rest of the world and hence on the world demand for British output.
The argument postulated by this question, and the correct answer, is therefore clearly false.