inflation targeting

Imagine a thermostat for prices. Instead of letting inflation wander wherever it likes, the central bank publicly announces a number it will aim for — most commonly 2 percent a year — and then adjusts interest rates to keep inflation near that figure, nudging it down when it runs hot and up when it runs cold. This explicit, announced goal-plus-commitment is called inflation targeting, and since the 1990s it has become the dominant framework for monetary policy around the world.

The framework has a few pieces. First, a clear numerical target, often a point (2 percent) or a band (1 to 3 percent). Second, transparency: the bank publishes forecasts and explains its decisions so the public can hold it to account. Third, a forward-looking approach: because policy acts with long lags, the bank steers toward where it expects inflation to be in a year or two, not where it is today. The deep purpose is to anchor expectations — if everyone trusts that inflation will be about 2 percent, workers do not demand huge wage rises and firms do not jack up prices defensively, which makes the target partly self-fulfilling.

Inflation targeting has generally coincided with lower, more stable inflation, and most economists regard it as a success — but it has honest limits and critics. It can pay too little attention to asset bubbles, financial stability, or unemployment if those are not in the target. The chosen number (why 2 percent and not 3 or 4?) is somewhat arbitrary. And it works far better against inflation than deflation: once rates hit zero, a bank can struggle to push inflation up toward target at all, as Japan's long fight with below-target inflation showed.