Comment

Abstract

Aclassic theme inmonetary economics is the crucial role of the credibility of central banks for the effectiveness of monetary policy. This raises two important questions. First, can we measure the evolution of the credibility of a central bank? Second, how can a central bank establish credibility? Goldberg and Klein propose a novel empirical analysis to test the evolution in credibility of the European Central Bank (ECB) between January 1999 and mid-2005. The nice feature of their work is that they use market responses to elicit information about the ECB credibility. Their main conclusion is that over this time period, the credibility of the ECB has increased whereas the credibility of the Federal Reserve Bank has been relatively stable. Moreover, looking at the history of policies implemented by the ECB in the same time period, they argue that the ECB credibility increase was linked to its policy actions. First, they present a standard New Keynesian model, following Gürkaynak, Sack, and Swanson (2005), to analyze the effect of an increase in the central bank’s credibility on the response of the yield curve to news. Then, they use high-frequency asset price data to test the time variation in the response of European and American yield curves to inflation news. In particular, they focus on term spreads between 10-year and 2-year interest rates for German, French, Italian, and U.S. government bonds and on the euro-dollar exchange rate. They look at the change in these term spreads and in the exchange rate 30 minutes before and after each monthly release of the U.S. core consumer price index (CPI). The news component is defined as the difference between the actual release value and the markets’ prior expectation of this release. Owing to data restrictions, the authors cannot use inflation news for each specific country, but they argue that the U.S. core CPI also contains news about inflation in euro area countries.