What Is Central Bank Credibility?
Central-bank credibility is the degree to which people believe the bank will keep inflation near its target; when credibility is high, inflation expectations stay anchored and shocks fade quickly, and when it is lost, inflation becomes persistent and far more painful to bring down.
Because inflation depends on what people expect (see the Phillips curve), the central bank's promise to keep prices stable is itself an economic force. Credibility is whether that promise is believed.
Anchored vs un-anchored expectations
When a bank is credible, expectations are "anchored": a one-off shock pushes inflation up briefly, then it settles back toward target because everyone assumes the bank will act. When credibility is lost, expectations chase whatever inflation happens to be, so shocks linger and feed on themselves.
Why it is expensive to lose
Credibility is lost quickly and rebuilt slowly. The 1970s showed how un-anchored expectations make inflation stubborn; the Volcker disinflation showed that rebuilding credibility can require a deep, deliberate recession. The reward is real: once anchored, the same shocks cause smaller, shorter inflation, which is why the post-2021 surge came down with far less unemployment than the 1980s.
In the simulator, "Central bank credibility" is a lever, and it is also endogenous: run inflation hot for long enough and trust erodes on its own.