Living Up to Expectations: Central Bank Credibility, the Effectiveness of Forward Guidance, and Inflation Dynamics Post-Global Financial Crisis

Stephen Cole, Enrique Martinez-Garcia and Eric Sims ()
Authors registered in the RePEc Author Service: Enrique Martínez García ()

No 31777, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper studies the effectiveness of forward guidance when central banks have imperfect credibility. Exploiting unique survey-based measures of expected inflation, output growth, and interest rates, we estimate a small-scale New Keynesian model for the United States and other G7 countries plus Spain allowing for deviations from full information rational expectations. In our model, the key parameter that aggregates heterogeneous expectations captures the central bank's credibility and affects the overall effectiveness of forward guidance. We find that the central banks of the U.S., the U.K., Germany, and other major advanced economies have similar levels of credibility (albeit far from full credibility); however, Japan's central bank credibility is much lower. For each country, our measure of credibility has declined over time, making forward guidance less effective. In a counterfactual analysis, we document that inflation would have been significantly higher, and the zero lower bound on short-term interest rates much less of an issue, in the wake of the Global Financial Crisis had the public perceived central bank forward guidance statements to be perfectly credible. Moreover, inflation would have declined more, and somewhat faster, with perfect credibility in the wake of the inflation surge post-COVID-19.

JEL-codes: E0 E32 E5 (search for similar items in EconPapers)
Date: 2023-10
New Economics Papers: this item is included in nep-ban, nep-dge, nep-eec and nep-mon
Note: EFG ME
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Related works:
Working Paper: Living Up to Expectations: Central Bank Credibility, the Effectiveness of Forward Guidance and Inflation Dynamics Post-Global Financial Crisis (2023)
Working Paper: Living Up to Expectations: Central Bank Credibility, the Effectiveness of Forward Guidance, and Inflation Dynamics Post-Global Financial Crisis (2023)
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