Inflation targeting
Inflation targeting is an economic policy in which the
central bank of a country estimates and makes public a projected or "target" inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools.
Because
interest rates and the
inflation rate tend to be inversely related, the likely moves of the central bank to raise or lower interest rates become more transparent (under the policy of inflation targeting).
Example A) if inflation appears to be above the target, the bank is likely to raise interest rates. This usually (but not always) has the effect over time of cooling the economy and bringing down inflation.
Example B) if inflation appears to be below the target, the bank is likely to lower interest rates. This usually (again, not always) has the effect over time of accelerating the economy and raising inflation.
Under inflation targeting, investors know what the central bank considers the target inflation rate to be and therefore may more easily factor in likely interest rate changes in their investment choices. This is viewed by inflation targeters as leading to increased economic stability.
Inflation targeting is in use by
Britain,
South Korea and
Brazil, among other countries, and there is some empirical evidence that it does what its advocates claim. [
1]
