Measuring the Policymaker’s Credibility: The Bank of England in ‘nice’ and ‘not-so-nice’ times
In the course of the last year or so, the Bank of England has come under pressure to raise interest rates on the grounds that a ‘lax’ monetary policy in the face of persistent overshoots of the inflation target risks undermining the Bank’s hard-won credibility. Using the Bayesian as well as time-varying coefficient Kalman-Filter techniques, and four different measures of inflation expectations, this paper looks at the effect of recent events upon the Bank of England’s credibility. Briefly, we find that on most measures of inflation expectations the credibility built up during the relatively benign years from the adoption of an explicit inflation target in 1992 to the onset of the financial crisis in 2007 has deteriorated since. Although our investigation is focused in this paper on the Bank of England, it is easily transferred to the examination of other central banks and represents an advance on other measures of credibility widely used in the existing literature.
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