Trust, Expectations and Monetary Policy: Why Central Bank Credibility Matters

Public trust is one of the most important foundations of effective monetary policy. For central banks, credibility is not simply a matter of reputation or institutional legitimacy. It directly influences how households, businesses and financial markets respond to policy decisions, ultimately determining how effectively monetary policy can control inflation and support economic stability.

However, persistent inflation, geopolitical tensions, economic uncertainty and repeated global shocks have placed this trust under increasing pressure. In a speech delivered as part of the 24th Sir Leslie Melville Lecture, the Reserve Bank of Australia (RBA) examined why public confidence matters, how it influences monetary policy and what central banks must do to maintain it.

Why Trust Is Essential to Central Banking

Trust plays a fundamental role in the monetary system because money itself depends on confidence. Banknotes and bank deposits have no intrinsic value outside the monetary system. Their purchasing power relies on the expectation that other people will continue accepting them at a broadly similar value in the future.

That confidence depends heavily on central banks maintaining price stability.

For decades following the 1980s, flexible inflation-targeting frameworks helped central banks deliver relatively low and stable inflation alongside rising real incomes. However, the period following the COVID-19 pandemic has been more challenging. Inflation remained above target for extended periods, putting pressure on central banks’ credibility and contributing to declining confidence in public institutions.

The global economic environment has also become increasingly volatile and unpredictable. Trade tariffs, wars, geopolitical tensions, pandemics and technological and environmental changes have created additional challenges for policymakers.

These developments make inflation more likely to move away from target, increase the possibility of forecasting errors and create more difficult trade-offs for monetary policy.

Two Different Forms of Trust

Trust generally takes two forms.

The first is relationship-based trust, which people place in family members and close friends. It develops through shared experiences, loyalty, honesty and consistent behaviour. People do not need repeated proof of these qualities every time they interact with someone they trust.

The second form is trust in professionals and experts, including doctors, lawyers and pilots. In these relationships, competence is particularly important. People rely on specialists because they possess the knowledge and technical skills needed to perform tasks that others cannot easily evaluate themselves.

This creates a challenge: individuals often lack the expertise required to independently assess the professionals on whom they depend.

Transparency and accountability help address this problem. Experts must explain their qualifications, reasoning and decisions, while independent scrutiny and assessments of outcomes provide additional safeguards.

The principle of trusting institutions while verifying their performance is equally important for central banks.

A trusted public institution must demonstrate four essential qualities:

• Integrity and public purpose: It must act honestly, consistently and in the long-term interests of society.
• Competence: It must possess the skills, resources and judgement required to achieve its objectives.
• Transparency: It must explain its decisions, objectives, uncertainties and mistakes clearly.
• Accountability: It must remain open to scrutiny and accept responsibility for its actions.

These qualities reinforce one another. Technical competence alone cannot sustain public confidence without integrity and a clear public purpose. Similarly, good intentions are insufficient if an institution cannot deliver effective results.

How Public Trust Influences Monetary Policy

Monetary policy operates with a time lag, meaning that its costs often appear before its benefits.

When inflationary pressures become excessive, central banks may raise interest rates to restrain demand. Over time, weaker demand helps reduce inflation and return the economy to a more balanced position.

However, households and businesses must often make difficult financial adjustments while the effects of tighter monetary policy gradually pass through the economy.

During this period, people need confidence that the central bank is acting competently, explaining the reasons behind its decisions and pursuing the public’s long-term interests.

The importance of trust becomes even greater when inflation is driven by negative supply shocks, such as rising energy costs. These developments can increase prices while simultaneously weakening economic activity, making the policy trade-off more difficult.

Why Expectations Matter for Interest Rate Decisions

Trust has a direct impact on the effectiveness of monetary policy because current decisions depend partly on what people expect the central bank to do in the future.

If households and businesses believe the central bank will eventually return inflation to target, they are more likely to adjust their spending, pricing and wage expectations accordingly.

This means monetary policy can influence economic behaviour before all of its effects are fully reflected in interest rates.

The RBA’s economic modelling illustrates this difference. When people do not expect tighter monetary policy to remain in place, they respond mainly to each individual rate decision. Spending and inflation consequently decline more gradually.

By contrast, when people understand and trust the central bank’s strategy, they anticipate future policy decisions and adjust their behaviour earlier. Even if the actual path of interest rates is identical, output and inflation respond more quickly and strongly.

This suggests that credible communication can reduce the amount of monetary tightening required to achieve a particular reduction in inflation, limiting the associated economic costs.

How Trust Can Reduce the Cost of Inflationary Shocks

The same principle applies when the economy experiences a temporary increase in overseas costs, such as higher oil prices.

If businesses do not trust the central bank to bring inflation back to target promptly, they may pass more of their increased costs on to consumers. Employees may also demand higher wages in anticipation of continuing price increases.

This can turn a temporary cost shock into more persistent inflation across prices and wages. The central bank may then need to raise interest rates more aggressively and reduce demand substantially to restore price stability.

However, when businesses and households trust the central bank’s commitment to controlling inflation, their behaviour can help limit the initial impact.

Companies may be less inclined to increase prices because they expect future policy to reduce cost pressures and demand. This can also moderate upward pressure on wages.

As a result, interest rates may not need to rise as sharply, reducing the economic cost of bringing inflation back to target.

Evidence from Australia supports this relationship. Research from Macquarie University’s Business Outlook Scenario Survey found that businesses expecting the RBA to restore inflation to target more promptly planned to pass on a smaller share of their costs associated with the Middle East conflict.

Australian households reporting greater trust in the RBA also tended to have lower near-term inflation expectations. Similar findings have been identified in research by the European Central Bank.

Central Bank Independence and Accountability

Most countries delegate monetary policy decisions to central banks that operate independently of their governments.

This arrangement reflects evidence that greater central bank independence is associated with more stable economic activity, lower and less volatile inflation, and better-anchored inflation expectations.

Independent institutions can make decisions based on economic conditions and long-term policy objectives rather than short-term political pressures.

Despite increased scrutiny following the COVID-19 pandemic, central bank independence has remained largely intact. According to the figures presented in the speech, 83% of central banks were as independent as they had been before the pandemic, while 15% had become more independent.

However, independence does not mean that central banks should operate without accountability. Unlike elected governments, they must demonstrate their performance through other mechanisms, including public communication, parliamentary scrutiny and independent reviews.

Measuring Public Trust in Central Banks

Economic conditions have created a difficult environment for central banks. Although employment and economic growth have remained relatively resilient in many countries despite substantial monetary tightening, inflation has continued to cause public frustration.

Households frequently identify inflation as their biggest economic concern, while consumer confidence remains weak.

Traditional economic indicators do not fully explain the strength of this dissatisfaction. The reduction in inflation following its post-pandemic peaks has involved relatively small declines in economic output compared with many previous periods of disinflation.

Similarly, the combination of inflation and unemployment, often measured through the misery index, has remained only slightly above its average level during the 15 years before COVID-19.

However, these measures overlook an important factor: the cumulative increase in prices.

In Australia, the total rise in prices since the pandemic has been substantially greater than during other monetary tightening periods since inflation targeting was introduced. Similar patterns can be observed in the United States and other developed economies.

Even when the inflation rate declines, the accumulated increase in the cost of living does not disappear. This distinction helps explain why households may remain dissatisfied even after inflation begins to moderate.

What Australia’s Surveys Reveal About RBA Credibility

The RBA’s Community Research Survey, launched in February of the previous year, provides insight into public confidence in the institution.

Four survey waves collected responses from approximately 12,000 Australians across different regions and sections of society. The latest survey referenced in the speech was conducted in September.

The results showed that approximately 55% of respondents had high or moderately high trust in the RBA. This placed the central bank relatively high among Australian public institutions.

Overall trust remained broadly stable, or increased slightly, during the preceding 18 months. This was notable because the period included higher interest rates and inflation significantly above the target range.

However, the more detailed results revealed a more complicated picture.

Confidence in the RBA’s ability to achieve its objectives in the short term had declined significantly. Respondents were less confident about the institution’s ability to deliver the desired economic outcomes over a one-year horizon.

The findings also showed that public trust depends on more than economic performance.

Three additional factors played an important role:

1. Process competence

People want decisions to be based on evidence, facts and sound economic reasoning. They also expect central banks to respond promptly when conditions require action. Survey scores for these measures were positive and had improved slightly since February 2025.

2. Transparency

Public confidence is influenced by whether institutions communicate openly, provide sufficient information and explain their decisions in understandable language. Measures of transparency had improved recently, potentially offsetting some of the negative effects of weaker economic outcomes.

3. Institutional values

People also assess whether central banks act with integrity, understand the impact of their decisions, support public wellbeing and maintain appropriate distance from political influence.

These values measures remained relatively strong and stable. Statistical analysis indicated that they played a particularly important role in explaining overall trust, a finding also identified in research involving the European Central Bank.

The results suggest that public confidence depends not only on whether a central bank achieves its objectives but also on whether people believe it is acting in their interests.

Inflation Expectations Provide Another Measure of Trust

Long-term inflation expectations offer another way to evaluate central bank credibility.

In Australia, market-based expectations and economists’ forecasts remained broadly anchored within the RBA’s 2–3% inflation target. Other developed economies showed similar patterns.

However, stable average expectations do not tell the entire story. Research suggests that declining confidence may also become visible when inflation expectations respond more strongly to changes in monetary policy.

If financial markets doubt a central bank’s commitment to restoring price stability, they may begin adjusting their expectations based on how policymakers respond to economic developments.

Australian long-term market expectations have generally remained relatively unresponsive to policy changes, suggesting that they are still reasonably well anchored.

The picture is less reassuring among businesses. Companies participating in the Business Outlook Scenario Survey had become less confident that inflation would return to target over the following five to ten years.

The RBA’s business liaison contacts reported similar concerns. Although Australia lacks a reliable measure of households’ long-term inflation expectations, persistent concern about the cost of living suggests that household confidence may also be under pressure.

A More Uncertain Global Economy Is Testing Central Banks

The global economic environment is becoming more difficult to manage, particularly because of four interconnected challenges:

• Volatility: More frequent economic shocks increase the likelihood of inflation moving away from target.
• Uncertainty: Greater uncertainty makes economic forecasts less reliable.
• Complexity: Policymakers must understand a growing number of structural and cyclical factors affecting inflation and employment.
• Ambiguity: Geopolitical developments and policy decisions can produce outcomes that are difficult to anticipate.

Supply-side disruptions create additional complications by increasing inflation while weakening economic activity and employment growth.

There is also a risk that public trust, although difficult to build, can disappear quickly. Confidence accumulated during more favourable economic periods may provide some protection when conditions deteriorate, but that protection should not be taken for granted.

The RBA warned that there may be a point at which public confidence reaches a breaking point. Maintaining trust therefore requires continuous effort, particularly when economic outcomes fall short of expectations.

How the RBA Plans to Strengthen Public Trust

The RBA’s approach focuses on maintaining its public purpose, improving institutional competence, strengthening communication and increasing accountability.

Maintaining a Clear Public Purpose

The RBA’s mandate is rooted in promoting the economic prosperity and welfare of the Australian people.

This objective was shaped in part by Leslie Melville, who contributed to the intellectual foundations of the Commonwealth Bank Act 1945. The legislation established the Bank’s responsibility for economic prosperity and welfare, including price stability and full employment.

The RBA continues to use these objectives as the foundation for its decisions.

However, achieving them can involve difficult trade-offs. Policies that improve economic conditions over time may create short-term costs, and the benefits may not always be immediately visible or evenly distributed.

To strengthen public confidence, the Bank aims to listen more closely to households and businesses, understand how its decisions affect different groups, particularly vulnerable people, and communicate openly about the reasoning behind its actions.

Investing in Economic Research and Expertise

The RBA is also investing in the skills and analytical tools required to navigate a more uncertain economic environment.

Its priorities include four main areas.

1. Understanding future economic challenges

The Bank is expanding its research into emerging economic issues, including artificial intelligence. It is also increasing engagement with external researchers, publishing more staff research through Insight Notes and establishing a financial markets research and modelling hub.

2. Improving economic models and policy frameworks

The RBA is extending its modelling capabilities to assess alternative economic scenarios and their implications for monetary policy.

Its modelling suite includes:

• MARTIN, its core macroeconometric model.
• DINGO, a dynamic stochastic general equilibrium model.
• HALLIE, a next-generation Heterogeneous Agent New Keynesian model.
• Non-linear structural labour market models.

The Bank is also developing its monetary policy implementation framework. Its published Framework for Additional Monetary Policy Tools explains how it could use its balance sheet if interest rates again reached the effective lower bound.

3. Improving data and economic intelligence

The RBA is expanding its access to economic data through partnerships with other organisations.

These initiatives include WHAM, a Wealth and Housing Assets Module developed with government agencies and the Australian Bureau of Statistics.

The Bank is also working with SEEK on labour market data, Macquarie University on business survey information and the Melbourne Institute on household inflation expectations.

Its liaison network conducts approximately 900 meetings each year with organisations across Australia. The information gathered through these discussions provides valuable insights into economic conditions and can increasingly be analysed using advanced artificial intelligence tools.

4. Improving decisions under uncertainty

Rather than relying exclusively on a central economic forecast, the RBA is placing greater emphasis on alternative scenarios.

Policymakers must consider not only what they expect to happen but also how the economy could develop differently and what policy responses might be required.

The Bank is also reviewing previous forecasts and policy judgements to identify areas for improvement.

Why Clear Communication Is Essential

Even better research and policy tools cannot eliminate unexpected economic shocks. A more volatile global environment will continue to create difficult decisions and increase the risk of inflation moving away from target.

Central banks must therefore explain their decisions clearly, particularly in three areas.

Why inflation is above or below target: People need to understand whether deviations result from unexpected shocks, policy trade-offs, forecasting limitations or the timing and calibration of monetary policy.

How the economy is expected to develop: Central banks should explain their economic outlook, the risks surrounding it and the mechanisms driving inflation and employment.

How policymakers intend to restore price stability: Institutions must explain how they balance full employment against the speed of disinflation and how they would respond to risks that have not yet materialised.

This does not mean promising a specific future path for interest rates. Instead, central banks should explain their reaction function: how policy would adjust as economic conditions change.

There is an important difference between explaining a policy strategy and guaranteeing a particular interest rate outcome. The objective is to help the public understand the central bank’s approach without creating unrealistic expectations.

Different Audiences Require Different Communication Strategies

Financial markets and the general public do not interpret economic developments in the same way.

Market expectations influence short-term interest rates and other financial prices, helping transmit monetary policy throughout the economy. Research suggests that central bank communication about issues such as housing risks and wages can influence how investors assess policymakers’ priorities.

However, communication with households and businesses requires a different approach.

People often interpret economic news and its implications for interest rates differently from financial market participants. Research conducted by the RBA suggests that households pay attention to the Bank’s actions and communications and want more information, although significant gaps remain in their understanding of economic relationships.

One particularly important gap concerns how higher interest rates help reduce inflation.

To address this, the RBA is developing more targeted communication strategies for households and businesses.

These include the Governor’s media conferences, detailed publications such as the Statement on Monetary Policy, shorter summaries, website explainers and digital content designed for people with different levels of economic knowledge.

Research indicates that even relatively simple explanations can improve public understanding of economic relationships and increase trust.

The RBA reported encouraging early results, including improvements in survey measures of openness, honesty and the clarity of its explanations. Nevertheless, the Bank intends to continue refining its approach so people can access useful information without having to read lengthy technical publications.

Accountability Remains Essential to Central Bank Independence

Public accountability brings together institutional values, competence and transparency.

The RBA remains accountable to the Australian public through parliamentary appearances and other forms of public engagement.

New five-year reviews of the Bank are also expected to strengthen accountability by providing regular assessments of institutional performance and opportunities for improvement.

The principle is straightforward: central bank independence must not mean freedom from scrutiny.

Clear communication is ineffective if policy decisions do not contribute to better economic outcomes. Similarly, competent decisions cannot maintain public confidence if people do not understand why difficult measures are necessary or believe the institution is acting in their interests.

Values, competence, transparency and accountability must work together to sustain trust.

Conclusion: Trust Is Essential for Effective Monetary Policy

Public trust is not an optional feature of central banking. It is a fundamental part of how monetary policy works.

When households, businesses and financial markets believe a central bank is committed to achieving its objectives, they are more likely to adjust their behaviour in ways that support those goals. This can make monetary policy more effective and reduce the economic costs of controlling inflation.

The RBA’s research suggests that public confidence has remained relatively resilient despite a difficult economic period. However, declining confidence in the Bank’s ability to deliver its objectives, particularly regarding inflation, remains a warning sign.

A more volatile and uncertain global economy will continue to test central banks. Maintaining credibility will require stronger analytical capabilities, clear explanations, consistent decisions and a willingness to accept public scrutiny.

The central message is that trust must be continuously earned. Central banks need to listen, learn, invest in the tools required to deliver effective policy, explain their decisions and remain accountable when outcomes fall short.