Abstract
This paper creates an asymmetric credibility indicator to measure the credibility of inflation-targeting central banks. The proposed indicator is computed for a sample of eight representative central banks using the inflation expectations survey data of professional forecasters and observed inflation data. The computed indicators are then used in the panel models to explore the credibility effect for central banks of emerging and advanced economies. The finding suggests that the presence of credibility makes significant changes in the constituents of inflation expectations. It makes the elements of backward-looking expectations insignificant and considerably increases the relative weight of the inflation target in the expectations formation. Further, the findings show that despite positive inflation shock in the global financial crisis, the inflation expectations were found well anchored. These findings have important policy implications for the conduct of monetary policy that credible inflation-targeting central banks can anchor forecasters’ inflation expectations in the crisis period such as COVID-19 crisis.
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Notes
- 1.
Theoretically, this issue can be traced to a widely cited study of the time-consistency problem (Kydland & Prescott, 1977).
- 2.
- 3.
This model assumes that the media and professional inflation forecasts affect households’ inflation expectations.
- 4.
Another tool to reduce this disbelief can be using an effective central bank communication policy.
- 5.
The study tests this hypothesis for the GFC inflation shock to see whether expectations made during this crisis period in which agents experienced inflation significantly higher than their expected inflation.
- 6.
Note that in the developing countries, the target bound is usually defined in a very broader range than developed countries to have more policy rate room for output considerations.
- 7.
The selection of sample data is constrained by data availability; most IT central banks started conducting expectations surveys recently.
- 8.
Further, it should be noted that the success of inflation targeting depends on the degree of long-term expectations anchoring. The complete anchoring to the midpoint of the target thus suggests perfect credibility.
- 9.
Further, most emerging economies are still in the initial stage of achieving a low inflation regime. These economies have adopted the broader target bound in the conduct of monetary policy to accommodate temporary shocks.
- 10.
These tests assume the existence of different unit roots in different cross sections.
- 11.
Note that the fixed-effect model for a group of four emerging economies could not be estimated due to low data points for India (fourteen data points and for Indonesia (nineteen data point). However, we include all four sample emerging economies data in the full sample estimation.
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Acknowledgements
This work was supported by the Indian Council of Social Science Research (ICSSR) IMPRESS scheme (File no: IMPRESS/P3357/24/2018-19/ICSSR). The author thanks the anonymous referee for the valuable comments and suggestions.
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Bicchal, M. (2022). Assessing the Credibility of Inflation-Targeting Central Banks. In: Yoshino, N., Paramanik, R.N., Kumar, A.S. (eds) Studies in International Economics and Finance. India Studies in Business and Economics. Springer, Singapore. https://doi.org/10.1007/978-981-16-7062-6_5
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