Definition
- Inflation targeting
- Inflation targeting is a rule that requires a central bank to focus primarily on keeping inflation low.
- Not to be confused with: Countercyclical policy
- Countercyclical policy moves in the opposite direction to the business cycle, loosening in downturns and tightening in upswings.
Inflation targeting in brief
Inflation targeting is a monetary policy framework in which the central bank commits to keeping inflation at or near a published figure, and adjusts interest rates to do so. A clear target helps households and firms expect stable prices, which makes wage and price decisions easier.
The figure
New Zealand's central bank was the first in the world to adopt formal inflation targeting.
Source: Reserve Bank of New Zealand, 35 years of flexible inflation targeting.
Common questions
- Which country started inflation targeting?
- New Zealand adopted the first formal inflation target, set by its central bank, as the figure here from the Reserve Bank of New Zealand shows.
- Why target inflation rather than the money supply?
- The link between the money supply and prices proved unreliable, whereas a stated inflation target gives people a clear signal to anchor their expectations.
- What is a weakness of inflation targeting?
- Interest rates act slowly and cannot fix supply shocks, so inflation can sit away from the target for some time.
Test yourself
What is the difference between inflation targeting and countercyclical policy?
Inflation targeting says what the central bank aims at; countercyclical policy says which way it leans through the cycle.