Inflation Targeting

 

Inflation targeting is basically a monetary policy system wherein the central bank of a country (RBI in India) has a specific target inflation rate for the medium-term and publicises this rate. It is assumed that at best the monetary policy could do in order to support growth for the long term is to sustain price stability. The main short-term tool the central bank utilises in this regard is the interest rate.

The central bank will hike interest rates if it is above-target inflation. And, it will decrease the interest rates in case of below-target inflation. The reason being, increasing the interest rates generally slows the economy to curb inflation, and reducing the interest rates will accelerate the economy, thus, augmenting inflation.