Definition
Central bank credibility is the extent to which households, firms, and financial markets believe a central bank will actually do what it says — most importantly, that it will keep inflation near its announced target. Credibility is an intangible asset, built slowly through consistent action and lost quickly through broken promises.
It matters because monetary policy works partly through expectations. A central bank's words move the economy only if people expect those words to be backed by follow-through.
Why it matters
How it works
When people trust the central bank's target, they build that expectation into wage demands, price-setting, and contracts. The result is a self-reinforcing equilibrium where the target is met largely without aggressive intervention. The bank's announcement does much of the work.
If credibility erodes, expectations become unmoored: people expect higher inflation, act on it, and make it real. Restoring credibility then requires painful, sustained tight policy. This is why central banks guard their reputations carefully, communicate transparently, and value independence — all to make their commitments believable.