Under this framework, a central bank sets an explicit target for the inflation rate and uses its monetary policy tools to achieve and maintain that target. The target is typically defined as a specific inflation rate or a range of inflation rates over a specific time horizon. Central banks may choose different targets depending on their country's economic conditions and policy objectives.
To implement inflation targeting, central banks use various monetary policy tools, such as interest rate adjustments and open market operations.
If inflation exceeds the target, the central bank may raise interest rates or reduce the money supply to cool down the economy and lower price pressures. Conversely, if inflation remains below the target or the economy needs stimulus, the central bank may lower interest rates or increase the money supply.
Inflation targeting has gained popularity since the early 1990s and is widely used by many central banks around the world. It is considered a transparent and accountable monetary policy framework that helps anchor inflation expectations and provide a predictable environment for businesses and households to make economic decisions. By keeping inflation stable, central banks aim to promote long-term sustainable economic growth and maintain price stability, which is crucial for a well-functioning economy.
It's important to note that the effectiveness of inflation targeting depends on various factors, including the central bank's credibility, the accuracy of economic forecasts, and the flexibility of the monetary policy framework to respond to changing economic conditions. Additionally, inflation targeting is just one approach to monetary policy, and different central banks may adopt alternative strategies based on their specific circumstances and policy objectives.
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