By Mervyn King, an Executive Director of the Bank and its Chief Economist.
Mervyn King, an Executive Director of the Bank and its Chief Economist, looks at the concept of credibility in monetary policy, why it is important and how it can be measured.
A monetary strategy is credible if the public believes that the government will actually carry out its stated plans; if their strategy is not credible, monetary authorities will find they have an incentive to accommodate inflation expectations. By creating a ‘penalty’ for failure, an announced inflation target—like that at the centre of the UK monetary framework—can enhance monetary policy credibility.
He explains how information about expectations of future inflation—and so about credibility—can be derived from the prices of government bonds. And he suggests that part of the increases in bond yields in 1994 reflected a reappraisal of the long-term credibility of the monetary policies of the different countries.
Credibility and monetary policy: theory and evidence