Inflation Targeting
IntermediateInflation targeting is a monetary policy framework in which a central bank publicly commits to keeping inflation at or near a specific numerical target, and sets interest rates with that goal in mind.
Under inflation targeting, the central bank announces a target, often 2% a year, and uses its policy tools, mainly interest rates, to steer inflation towards it over the medium term.
New Zealand was the first country to adopt formal inflation targeting in 1990. Many central banks, including those of the United Kingdom, Canada, Australia and the euro area, now use inflation targets or similar frameworks. The US Federal Reserve also has a 2% inflation goal alongside its aim of maximum employment.
For example, if inflation rises to 5%, a central bank targeting 2% would typically raise interest rates to slow demand and bring inflation back down. If inflation falls well below target, it would cut rates.
A clear target helps anchor inflation expectations. If people and businesses believe the central bank will deliver low, stable inflation, they are less likely to push up wages and prices excessively. Critics note that focusing heavily on inflation may sometimes come at the cost of employment or financial stability, which is why many frameworks allow some flexibility.
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