Monetary policy credibility: A Phillips curve view

Abstract

► We investigate monetary policy credibility in eight countries. ► We test whether inflation expectations respond to changes in the nominal interest rate. ► With credible policy, an increase in the interest rate must decrease inflation expectations. ► Two of the eight countries exhibit robust credibility effects across samples. ► These results are sensitive to how inflation and the output gap are measured. The paper investigates the presence of monetary policy credibility in eight countries by filtering the residuals from an “augmented” Phillips curve. Two of the eight countries (US and New Zealand) exhibit robust credibility effects across samples. Two countries (South Africa and the UK) exhibit credibility effects in the sample involving the 1990s, but these effects disappear in the sample beginning in 2000. The rest of the countries do not exhibit monetary policy credibility. Given that seven of the eight countries have adopted an explicit inflation-targeting framework, we conclude that there is very weak evidence that this framework enhances monetary policy credibility. These results are however sensitive to how inflation and the output gap are measured.