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Inflation Targeting

Ankit0

Inflation targeting is a policy framework in which a central bank explicitly targets a specific inflation rate. This means that the central bank sets a target for inflation and then takes measures to achieve that target.

Key Principles of Inflation Targeting:

  • Explicit inflation target: The central bank sets a numerical target for inflation.
  • Monetary policy: The central bank uses its control over interest rates and other monetary policy tools to influence inflation.
  • Market-based: The central bank relies on market mechanisms to achieve the inflation target.
  • Transparent: The central bank is transparent about its inflation targeting strategy and its progress in meeting the target.

Types of Inflation Targeting:

  • Absolute inflation targeting: The central bank targets a specific absolute inflation rate.
  • Velocity targeting: The central bank targets the velocity of money supply.
  • Asset-based inflation targeting: The central bank targets inflation based on the asset price inflation.

Advantages:

  • Credibility: Can enhance credibility of the central bank and its ability to control inflation.
  • Inflation control: Can help to keep inflation under control.
  • Long-term stability: Can promote long-term economic stability.

Disadvantages:

  • Political pressure: Can lead to political pressure on the central bank to meet the target.
  • Inflexibility: Can be inflexible in response to shocks or economic changes.
  • Uncertainties: Can introduce uncertainties into the policy process.

Examples of Inflation Targeting:

  • The US Federal Reserve has used inflation targeting since 1992, targeting a 2% inflation rate.
  • The European Central Bank targets a 2% inflation rate.

Conclusion:

Inflation targeting is a policy framework that involves setting a specific inflation target and using monetary policy tools to achieve that target. It has advantages and disadvantages, and its effectiveness depends on a number of factors.

FAQs

  1. What is meant by inflation targeting?

    Inflation targeting is a monetary policy where central banks aim to keep inflation within a specific target range to ensure price stability.

  2. Why do we target inflation?

    Targeting inflation helps stabilize prices, boosts economic predictability, and supports sustainable growth by avoiding extreme inflation or deflation.

  3. What is the inflation target rule?

    The inflation target rule is a guideline central banks use to keep inflation at a set percentage, usually around 2%, by adjusting monetary policy.

  4. What is the RBI’s role in inflation targeting?

    The Reserve Bank of India (RBI) manages inflation by setting policy rates and using other tools to keep inflation within its target range.

  5. What is the current inflation target of the RBI?

    As of recent years, the RBI’s target is to maintain inflation around 4%, with a tolerance band of ยฑ2%.

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