Abstracts Category : Other

Measuring Central Bank Credibility From the Effect of Inflation Shocks on Asset Prices

by Junmei Xu

In the early 1990s, the Bank of Canada explicitly adopted the inflation-targeting framework for monetary policy, while the Federal Reserve did not; instead, the Fed settled on an implicit inflation-targeting framework. In this study, I test whether the Bank of Canada and the Federal Reserve earned credibility for their respective commitments explicit or otherwiseto maintain low and stable inflation. I model how credibility shapes the responses of asset prices to inflation shocks. And, for each country, I estimate responses of commodity and foreign exchange prices to announcements of inflation shocks during the periods of 1982 to 1991 (pre-inflation targeting period) and 1996 to 2005 (inflation-targeting period). I conclude that for Canada in the period 1996 to 2005, but not before, the Bank of Canadas commitment to maintain low and stable inflation was credible. For the US, the credibility of the Federal Reserve seems to have grown as well, though to a lesser extent relative to the Bank of Canada. Taken together, my results indicate that the Bank of Canada in the period1996 to 2005 is most credible, both relative to its own past and to the Federal Reserve. Advisors/Committee Members: Joseph Santos.