Glossary term
Inflation Targeting
Inflation targeting is a monetary policy framework in which a central bank publicly aims for a specific inflation rate over time.
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What Is Inflation Targeting?
Inflation targeting is a monetary policy framework in which a central bank publicly aims for a specific inflation rate over time. The target is meant to anchor expectations, guide policy decisions, and make the central bank's goals more transparent.
In the United States, the Federal Reserve has stated that inflation of 2 percent over the longer run, measured by the personal consumption expenditures price index, is most consistent with its mandate for maximum employment and price stability.
Key Takeaways
- Inflation targeting gives monetary policy a public inflation objective.
- The target helps households, businesses, and markets form expectations.
- Central banks usually pursue the target over time, not month by month.
- Policy still has to balance inflation, employment, financial conditions, and economic shocks.
How the Target Guides Policy
When inflation is above target, a central bank may tighten monetary policy by raising interest rates or reducing accommodation. When inflation is below target and economic activity is weak, it may ease policy to support demand and move inflation back toward target.
Condition | Possible Policy Response |
|---|---|
Inflation above target | Higher rates or tighter financial conditions. |
Inflation below target | Lower rates or more accommodative policy. |
Supply shock | More judgment because prices and employment may move in difficult directions. |
Stable expectations | Can make policy transmission more predictable. |
Expectations and Credibility
Inflation targeting depends on credibility. If households and businesses believe the central bank will keep inflation near its target over time, wage-setting, pricing, lending, and investment decisions may become more stable.
If credibility weakens, inflation expectations can drift. That can make inflation harder to control because people begin setting prices and wages around the expectation of higher future inflation.
Not a Mechanical Rule
Inflation targeting does not mean the central bank reacts mechanically to every monthly inflation report. Policy works with lags, and inflation data can be noisy. Central banks also consider employment, growth, financial stability, and the source of inflation.
For households, the target matters because it shapes interest rates, borrowing costs, savings yields, mortgage rates, and the long-run purchasing power of money.
The Bottom Line
Inflation targeting gives monetary policy a visible anchor. It can improve transparency and expectations, but it still requires judgment when inflation, employment, and financial conditions point in different directions.