Inflation target credibility and the Taylor rule

Abstract

This paper investigates how the ECB’s monetary policy affects consumers’ perceptions about the credibility of the inflation target. Monetary policy is assessed by the gap between the actual policy rate and a Taylor rate to approximate the interest rate expected by the public. Drawing on survey data for German consumers from 2019 to 2024, we find that the ECB’s interest rate policy contributes significantly to the credibility of the inflation target. In particular, the massive dent in inflation target credibility observed from 2021 to the end of 2023 could have been ameliorated by an earlier and more decisive tightening of monetary policy. This suggests that simple outcome-based Taylor rules may deserve more attention in the communication of the ECB’s monetary policy strategy.