13: The Great Recession and the Two Dimensions of European Central Bank Credibility
Timo Henckel, Centre for Applied Macroeconomic Analysis, Australian National University
Gordon D. Menzies, Economics Discipline Group, University of Technology, Sydney
Daniel J. Zizzo, School of Economics and CBESS, University of East Anglia
Date of publication: August 2013
Working paper number: 13
A puzzle from the Great Recession is an apparent mismatch between a fall in the persistence of European inflation rates, and the increased variability of expert forecasts of inflation. We explain this puzzle and show how country specific beliefs about inflation are still quite close to the European Central Bank target of 2% (what we call official target credibility) but the degree of anchoring to this target has gone down, implying an erosion of what we call anchoring credibility. A decline in anchoring credibility can explain increased forecast variance independently of any changes in inflation persistence, contrary to standard time series models.
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