DP940 | The Simplest Test of Inflation Target Credibility


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A simple test of inflation target credibility is constructed by subtracting the maximum and minimum inflation rates consistent with the inflation targets from the yields to maturity on nominal bonds. This results in a target-consistent range of real yields on nominal bonds. If expected real yields, or market real interest rates on real bonds if they are available, fall outside the range of target-consistent real yields, credibility is rejected. Two concepts of credibility, called absolute credibility and credibility in expectation, are distinguished. The credibility of inflation targets of Canada, New Zealand and Sweden are examined diagrammatically.