Central bank credibility: Then and now

T he t raditional view is that a central bank is credible if it succeeds in keeping the level of expected inflation on target, even if there are inflationary or disinflationary shocks. According to this criterion , the Federal Reserve was credible until the COVID crisis; the ECB has no longer been credible (expected inflation has been too low) since 2013-2014. But, given chronically low inflation and the absence of a correlation between inflation and the economic cycle, investors no longer adhere to this view of central bank credibility and no longer worry about a potential resurgence of inflation . A nother version of central bank credibility has arisen : are central banks capable of guaranteeing that there will be no public debt crisis, even with highly expansionary fiscal policies? Instead of providing investors with assurance against the risk of inflation, credible central banks provide assurance against the risk of a loss of government solvency. To determine whether central banks are credible according to this new definition, one needs to look at whether sovereign CDS remain low even when fiscal deficits become high . This is clearly the case today in the United States and the euro zone.