What is Inflation Targeting?
Inflation targeting is a monetary policy framework in which a central bank sets an explicit inflation rate goal and adjusts policy tools—especially interest rates—to achieve that target. It aims to maintain price stability while supporting sustainable economic growth.
Definition
Inflation targeting is a strategy where a central bank publicly commits to keeping inflation around a specific target range using monetary policy interventions.
Key Takeaways
- Central banks set a clear inflation target (e.g., 2%).
- Interest rate adjustments are the primary tool.
- Improves transparency, credibility, and economic stability.
Understanding Inflation Targeting
Under inflation targeting, central banks focus on keeping inflation predictable and stable. They monitor economic indicators such as consumer prices, employment, exchange rates, and GDP growth to determine whether inflation is rising or falling.
If inflation is above target, central banks may increase interest rates to reduce spending and borrowing. If inflation is below target, they may lower interest rates to stimulate economic activity.
Inflation targeting is widely used by central banks around the world, including the Bank of England, European Central Bank, and Bank of Botswana.
Real-World Example
The Bank of England has an inflation target of 2%. When inflation exceeded this level in 2022, the bank raised interest rates multiple times to bring prices back under control.
Importance in Business or Economics
Inflation targeting stabilizes economic expectations, reduces uncertainty, and supports long-term planning for businesses and households. It also strengthens central bank credibility and improves financial market predictability.
Related Terms
- Monetary Policy
- Interest Rate
- Consumer Price Index (CPI)
Sources and Further Reading
Quick Reference
- Purpose: Maintain stable inflation.
- Tool: Interest rate adjustments.
- Outcome: Predictable economic environment.
Frequently Asked Questions (FAQs)
Why do central banks target inflation?
To maintain stable prices and support sustainable economic growth.
What happens if inflation stays above target?
Central banks often raise interest rates or use other tightening measures.
Does inflation targeting prevent recessions?
Not entirely, but it helps reduce volatility and manage expectations.
