Did the 2022 energy inflation surge dent European Central Bank and Fed credibility? Evidence across horizons

The ultimate test of central bank credibility is whether it maintains price stability. However, inflation is affected by shocks. For these to wash out, long averaging is needed, delaying assessment of the central bank’s price-stability performance. It may be necessary to wait years to conclude whether a central bank did its job.

We propose a complementary credibility test that uses empirical proxies of inflation expectations instead of actual inflation as the variable to be stabilised. We apply our test to the energy inflation shock caused by Russia’s invasion of Ukraine and ask whether this significantly impacted European Central Bank and Federal Reserve credibility, with perfect credibility meaning no impact of current inflation on expected inflation over the appropriate horizon, while zero credibility implies full pass-through, or even a magnifying effect. We test credibility at various horizons and distinguish between speed credibility (the ability and willingness to act promptly, visible at short horizons) and destination credibility (the perceived commitment to the long-run target, visible at long horizons).

We find the ECB lost more speed credibility than the Fed but preserved its destination credibility. The Fed preserved speed credibility but showed more long-run drift. Current inflation significantly affected forecasts in both jurisdictions at the one-year horizon, but the effect was significantly larger in the euro area. At the two-year horizon, both central banks broadly maintained medium-term anchoring. At the longer horizon, the ECB avoided any effect of current inflation on inflation forecasts, while US expectations drifted somewhat. Overall, the energy inflation shock did not dent significantly the inflation credibility of either central bank, though we set out some nuances.

We gratefully acknowledge input from Andreas Billmeier, Rebecca Christie, Gene Frieda, Hans Geeroms and Guntram Wolff.