Inflation Targeting

Inflation targeting is a monetary-policy framework in which a central bank publicly commits to a numerical inflation goal and uses policy to guide inflation toward it.

Policy Rate: The interest rate a central bank sets or steers to influence borrowing and economic activity. Changing this rate is the main way an inflation-targeting bank influences demand and price growth.
Inflation: A sustained increase in the general price level that reduces the purchasing power of money. The framework is designed to keep this broad price movement near a stated rate.
New Zealand Inflation Targeting: The framework adopted by New Zealand in 1990, widely regarded as the first formal inflation-targeting regime. New Zealand’s adoption established the first prominent model for an explicit inflation target.
Inflation Target Band: A stated range within which a central bank aims to keep inflation over a specified horizon. Some frameworks define success with a range rather than a single exact rate.
Time Inconsistency: A conflict in which a policy that is optimal in advance becomes unattractive to policymakers later. A public target can constrain incentives to create surprise inflation after expectations are set.
Monetary Policy Transmission Mechanism: The chain through which central-bank actions affect financial conditions, spending, output, and prices. It explains how policy decisions can move inflation toward the announced goal.
Consumer Price Index: A statistical measure of changes in prices paid by households for a basket of goods and services. Many central banks specify their target using a consumer-price index.
Reserve Bank of New Zealand Act 1989: The law that reformed New Zealand’s central bank and established a framework for pursuing price stability. The act created the institutional basis for New Zealand’s early target regime.
Average Inflation Targeting: A framework that seeks inflation to average a target over time, allowing past shortfalls or overshoots to affect future policy. It differs from conventional targeting by making prior misses relevant to the future path.
Rational Expectations: The theory that people use available information and economic models when forming expectations. Target credibility depends partly on whether people believe policy will match the announced goal.

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