VSIt was following the great inflation of the 1970s that the notion of credibility entered the arsenal of economic concepts. Defeated by inflation, most governments from the 1980s converged on the same model: they made their central bank independent, gave it a narrow mandate (usually an inflation target) and have left free the means to reach it.
For central banks, the watchword has become credibility. Protected from political constraints and freed from the need to arbitrate between conflicting objectives, they concentrated on achieving their priority objective. Success was there: in the early 2000s, inflation had become a curiosity.
The independent central bank model withstood the rising risks of deflation well in the 2010s. Because they were credible, the monetary institutions were able to throw all their forces into the fight. Forward guidance (commitments on the “future direction” of monetary policy) or quantitative easing (“quantitative easing”, i.e. purchases of securities, especially public ones): following the suggestion of the American economist Paul Krugman, they were able to commit themselves credibly to act in an irresponsible way (” It’s Baaack: Japan’s Slump and the Liquidity Trap”, Brookings Papers on Economic Activity, 2/1998).
Monetary policy tightening
Today taken from behind by the sudden rise in inflation, they see with panic their credibility being eroded. It is to restore it that they are hastily raising their key rates. But since monetary policy only acts on inflation with a delay of around eighteen months, the risk, particularly in Europe, is that today’s tightening will worsen the recession that is looming tomorrow. This is the criticism that Sanna Marin, the Finnish Prime Minister, formulated very explicitly in a tweet criticizing central banks, which “protect their credibility by plunging economies into recession”.
It was this same credibility problem that fiscal policies faced during the interest rate hikes of the 1980s. Latin American debts. In the 2010s, it was then the euro zone that was hit by the sovereign debt crisis. A few weeks ago, it was finally the brutal reaction of the markets to his budgetary adventurism that brought down Liz Truss, the very ephemeral British Prime Minister.
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