Inflation Targeting

Inflation targeting is a monetary policy framework in which a central bank publicly announces a target inflation rate — typically around 2% — and adjusts interest rates to keep actual inflation near that target. The approach was pioneered by New Zealand in 1990 and subsequently adopted by the Federal Reserve, the European Central Bank, and most major central banks. Its theoretical justification rests on the premise that low and stable inflation reduces economic uncertainty, anchors expectations, and thereby facilitates long-term planning.

The framework assumes that inflation is the primary variable through which monetary policy affects the real economy. This assumption has been challenged by the experience of the 2010s, when massive quantitative easing produced only modest inflation, and by the post-pandemic surge, when supply shocks drove inflation well above target despite aggressive rate hikes. These episodes suggest that the relationship between monetary policy and inflation is neither stable nor unidirectional, and that inflation targeting may be a monetary policy rule optimized for a specific historical regime rather than a universal principle.