A Credibility Proxy: Tracking US Monetary Developments

The purpose of this paper is two-fold: first, we propose a method for checking empirically whether inflation expectations are anchored in the long run, and at what level. The extent of anchoring then serves as a proxy for the credibility of the monetary authority. Second, to assess how well this measure proxies credibility, we cross-check it against periods for which the level of credibility is known and generally agreed upon. To this end, we apply our measure to the US inflation history since 1963, which includes both the period of the Great Inflation, in which credibility was poor and deteriorating, as well as the period of the Great Moderation during which credibility in the monetary authority was gradually re-established. Finally we check what our measure of credibility tells us about the crisis period.