Policy Goals and Inflation Targeting
Central banks pursue price stability above all, alongside goals like high employment, growth, and financial stability. A nominal anchor ties down inflation expectations, and inflation targeting (a public numeric goal, often around 2%) is the dominant modern framework for providing that anchor.
Why it matters
A clear target anchors the inflation rate the public expects, so expectations settle around it and become partly self-fulfilling. Without an anchor, expectations drift and policy loses its grip.
Worked examples
Inflation is running at 5% under a 2% target. What does an inflation-targeting central bank do?
It tightens, raising the policy rate to cool demand and pull inflation back toward 2%. If instead inflation were below target with economic slack, it would ease.
Common mistakes
- ✗Price stability means zero inflation. Targets are a small positive number, around 2%, to keep a buffer against deflation and to allow for measurement bias.
- ✗Inflation targeting ignores jobs. Flexible inflation targeting also weighs employment and output, and only leans hard on inflation when it strays far from target.
Revision bullets
- •Goal hierarchy led by price stability
- •A nominal anchor pins inflation expectations
- •Inflation targeting uses a public numeric goal near 2%
Quick check
Why do most inflation targets sit near 2% rather than 0%?
Connected topics
Sources
- Mishkin (2018), Ch. 17Mishkin, F. S. The Economics of Money, Banking, and Financial Markets. 12th ed. Pearson, 2018. ISBN 978-1-292-26885-9.Goals of monetary policy, nominal anchors, and inflation targeting.