Evolving Perceptions of Central Bank Credibility: The European Central Bank Experience

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We present a novel empirical framework that uses high-frequency data to test for persistent variation in market perceptions of the reaction function of the European Central Bank (ECB) during its first 6 years of operation, from January 1999 to mid-2005. This episode serves as a natural experiment for considering the evolution of central bank credibility since the ECB began in an atmosphere of uncertainty, and controversy, as to its policy stance. We argue that these perceptions significantly evolved over this period, a conclusion based on tests of the effect of economic news announcements on the yield curves in the euro area and on the euro-dollar exchange rate. An increase in the perceived weight on inflation in the policy decisions of the ECB, or a view that inflation targets were lower than previously perceived, occurred in the wake of ECB monetary tightening. In contrast, there is no comparable evidence of any change in market perceptions of the reaction function of the Federal Reserve over this period.