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Since there are significant biases in the individuals’ inflationary expectations, the role of monetary policy credibility needs to be reconsidered. Theoretically, policy credibility can influence the policymaker’s plan of action or reflect his preference. Thus, when prices rise, perceived credibility not only stabilizes public expectations of inflation, but also becomes important information, which can be used by the individuals to improve their expectations. The econometric analysis of a large-scale survey largely confirms these theoretical predictions. The perceived policy credibility as well as inflation perceptions and education plays an important role in the individuals’ inflationary expectations

It has long been recognized that monetary policy has an inflationary bias when the policymaker makes an effort to increase growth rate (Barro and Gordon, 1983 and Kydland and Prescott, 1977). The public know such possibility, but have limited information about the policymaker’s preference. Thus, they can only deduce it from the past commitments and actions of the central bank. As a result, the monetary policy credibility that is perceived by the public has a strong influence on their opinions of inflation. The influence may motivate the policymaker to gain credibility since the public plays an important part in the effectiveness of monetary policy. Therefore, in a repeated game, the policymaker’s choice of inflation is different than that in a one-shot game (Backus and Driffill, 1985a, Backus and Driffill, 1985b, Cukierman and Liviatan, 1991, Cukierman and Meltzer, 1986 and Vickers, 1986). The policymaker who has a preference for economic growth must take account of the effects of monetary policy credibility and hence choose a relatively low rate of inflation at the beginning of a repeated game. The above theories share the view that individuals are rational and hence able to use all the relevant information in an optimal way to make unbiased judgments of future inflation. Unfortunately, this rational expectations hypothesis is challenged by the evidence from experiments and surveys. For example, the experiment of Jacobson and Obermiller (1990) demonstrated that the individuals’ inflationary expectations were affected by systematic error and did not reflect all the available information. This experiment implied expectations depended on current price and some unknown factors that produced a serially correlated error. Similarly, Simmons and Weiserbs (1992) conducted a survey and found that consumers utilized only recent inflationary perceptions for expectations. This relationship between inflationary perceptions and expectations is also supported by the studies of Carlson and Parkin, 1975, Defris and Williams, 1979, Jonung, 1981 and Wärneryd and Wahlund, 1985 and Gärling and Gamble (2008). Therefore, it was proposed by Ranyard, Del Missier, Bonini, Duxbury, and Summers (2008) that a conception of bounded rationality be adopted in order to explain the results of previous studies. In addition, some of the biases in inflationary expectations may reflect the differences in the individuals’ perceptions of inflation (Ranyard et al., 2008). The expectations can also be influenced by some other factors such as age, gender, personal assets and economic preferences (Jonung, 1981 and Webley and Spears, 1986). Since there are significant biases in inflationary expectations, the role of monetary policy credibility needs to be reconsidered. How does the credibility influence individuals’ expectations and their accuracy? This question has not been well answered by the previous literature. With the aim of making a contribution to this topic, this paper analyzes the relationship between monetary policy credibility and inflationary expectations in the following sections. The theoretical analysis is presented in Section 2. To test the main predictions of the theoretical model, Section 3 provides an econometric analysis of a recent large-scale survey of Chinese adults. Then Section 4 concludes the paper.

If a conception of bounded rationality is adopted to explain the significant biases in inflationary expectations, the role of monetary policy credibility needs to be reconsidered. Thus, we introduce credibility into the theoretical model to analyze the relationship between perceived policy credibility and inflationary expectations. Theoretically, monetary policy credibility can influence the policymaker’s plan of action or reflect his preference. Therefore, when prices rise, it helps stabilize inflationary expectations and becomes important information, which can be used to improve the individuals’ expectations. The econometric analysis of a large-scale survey largely confirms the above theoretical predictions. The results demonstrate that perceived policy credibility plays an important role in the individuals’ inflationary expectations. Furthermore, college education is found to have similar influence. These two factors seem to be supplements to each other. In addition, the individuals’ recent perceptions of price changes and lifetime experience of inflation also have a strong influence on expectations and their accuracy. The stronger predictors of expected inflation are perceived inflation, monetary policy credibility, and education, with the other factors playing a minor role. As regards gender, there is significant male–female difference, which indicates the influence of the individuals’ purchasing patterns on expectations of general inflation. The individuals on low incomes are also influenced by the burden of expenditure on food and houses. In addition, regional variation, which is significant in all the equations, may also be used to explain some differences in the individuals’ expectations. The predictive capacity of the econometric model is good but limited since the residual variance is high. A possible explanation is that some other factors not included in the model may have a strong influence on inflationary expectations. For example, the individual’s attitudes and career may also play an important role; economically-naive people may be much less affected by policy credibility. Thus, further empirical analysis is needed to take account of more factors. More importantly, there may be some potential carry-over effects of previous responses on subsequent responses in this survey, since so many inflation rates are inquired in a short time. To moderate such effects, the inflation-related questions are placed in the first part of the survey. Then some questions about purchasing behavior are placed between the inflation-related and the credibility-related questions to provide a gap. Moreover, no inflation rate is included in the answers to the question on the individual’s expectation of the central bank’s action. Thus, using this alternative credibility variable also helps reduce the carry-over effects. Furthermore, in this survey, most of the respondents are less than 55 years old (88.32%) and have a college education or above (65.75%). According to the studies of Narayan and Krosnick (1996) and Knäuper (1999), this character can moderate the carry-over effects. Besides, this survey can provide only cross-sectional data without regard to time dimension. Therefore, some improvements on survey methods seem necessary for future research to provide further insights into this topic.