Abstract
Credibility is crucial for managing inflation expectations in countries adopting inflation targeting. This study focuses on measurement of credibility and its relation with the interest rates. It aims to determine which measures of credibility best predict the variations of interest rates by using monthly data from Turkey in 2004−2012 period which adopted infla#on targe#ng in 2002. Nine credibility indices are considered in the analysis. We find empirical evidence supporting the claim that higher credibility will lead to lower variations in interest rates of both monetary policy and the market. We also demonstrated that CICK (proposed by Cecchetti and Krause, 2002) is the best credibility index in explaining the variations in both monetary policy interest rate and market interest rate.
Highlights
Dynamic inconsistency problem in monetary policy arises if the policymakers are unable to commit to a policy rule
We provide empirical evidence supporting the claim that higher credibility will lead to lower variations in interest rates of both monetary policy and the market
The measurement of credibility is important for the analysis of countries adopting inflation targeting
Summary
Dynamic inconsistency problem in monetary policy arises if the policymakers are unable to commit to a policy rule. The aim of this paper is to determine which measures of credibility best predict the variations of interest rates in Turkey. For this objective we used monthly data from Turkey between January 2004 and January 2012. CICVE and CICVX are proposed in this paper These indices measure the credibility by considering the deviation of the expected inflation from the inflation target. We provide empirical evidence supporting the claim that higher credibility will lead to lower variations in interest rates of both monetary policy and the market.
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