Does Monetary Policy Credibility Affect Market-Based Inflation Expectations?

Abstract

Evidence based on the counterfactual analysis reveals that an unexpected improvement in the monetary policy credibility neutralises the rate of increase of eight-year inflation expectations to the exchange rate depreciation and oil price inflation shocks. In addition, evidence-based on the counterfactual analysis indicates that the dampening effect of the improved monetary policy credibility is bigger when inflation exceeds 6% as eight-year inflation expectations rise by smaller magnitudes to positive inflation shocks. These results imply the credibility of the conduct of monetary policy in minimising the deviations of inflation from the target in the high inflation regime affect the rate at which market-based inflation expectations react to positive inflation shocks.