Inflation targeting is a framework for monetary policy in which a central bank publicly commits to keeping inflation at or near a specific numerical target, usually around 2% a year for advanced economies, and sets its policy interest rate to bring forecast inflation back to that target over a stated horizon. It typically comes with operational independence for the central bank, regular published forecasts and explanations of decisions, and accountability to parliament or government.
New Zealand pioneered the approach in 1990, and by the 2020s dozens of central banks used it, including the Bank of England, the Bank of Canada, the Reserve Bank of India and many emerging-market central banks. The Federal Reserve and the European Central Bank pursue numerical 2% inflation goals within broader mandates. Inflation targeting replaced earlier anchors such as fixed exchange rates and money-growth targets based on the quantity theory of money.
Inflation targeting in plain terms
Think of a home thermostat set to 20 degrees. When the room gets too warm, the heating turns down; when it gets too cold, the heating turns up. Everyone in the house knows the setting, so nobody needs to keep opening windows or adding blankets.
An inflation-targeting central bank works like that thermostat for prices. It announces the temperature it wants, say 2% inflation, and adjusts interest rates to get there: higher rates to cool spending when prices rise too fast, lower rates to warm things up when they rise too slowly. Because the target is public, businesses and workers can plan around it, which makes the thermostat's job easier.
How the framework works
- A numerical target. Usually 2% for consumer-price inflation, sometimes with a tolerance band.
- A policy instrument. The short-term policy rate, such as the federal funds rate or the Bank of England's Bank Rate, supplemented when rates are near zero by quantitative easing (QE) and forward guidance.
- Forecast targeting. Because policy works with lags of a year or two, decisions are based on where inflation is expected to be, not where it is today.
- Flexibility. Most central banks practise "flexible" inflation targeting, also weighing output and employment, so they may return inflation to target gradually after a supply shock.
- Transparency and accountability. Published minutes, forecasts and reports explain decisions; some, like the Bank of England, must write an open letter to the Chancellor when inflation misses the target by more than one percentage point.
Targets around the world
| Central bank | Target (as of 2026) | Notes |
|---|---|---|
| Reserve Bank of New Zealand | 1%–3%, focus on 2% midpoint | First formal inflation targeter, from 1990 |
| Bank of England | 2% CPI | Targeting since October 1992; CPI target since 2003; set by the government |
| Federal Reserve | 2% PCE inflation | Explicit goal since 2012 within a dual mandate |
| European Central Bank | 2% HICP, symmetric | Reaffirmed in the strategy assessment of June 2025 |
| Bank of Japan | 2% CPI | Adopted in January 2013 |
| Reserve Bank of India | 4% CPI, band 2%–6% | Since 2016; retained in March 2026 for April 2026–March 2031 |
| State Bank of Pakistan | 5%–7% medium-term range | Range first stated in 2021 |
The Federal Reserve revised its framework in 2020 to "flexible average inflation targeting", aiming to make up for past shortfalls, then dropped the averaging approach in its revised Statement on Longer-Run Goals in August 2025 while keeping the 2% goal. The European Central Bank (ECB) concluded a strategy assessment on 30 June 2025 that kept its symmetric 2% target, and plans the next review for 2030.
Why central banks adopted it
The framework grew out of the high inflation of the 1970s and the costly disinflations that followed. Money-growth targets had failed because the velocity of money proved unstable, and fixed exchange rates broke down in crises such as the UK's exit from the European Exchange Rate Mechanism in September 1992, after which the UK adopted inflation targeting. Supporters argue that a clear target anchors expectations, reduces the risk of a wage-price spiral and limits political pressure on monetary policy. The period of low and stable inflation in many advanced economies from the 1990s, part of the Great Moderation, is often credited partly to the framework.
Criticism and debates
- Financial stability. Critics argue that a narrow focus on consumer prices let asset bubbles and credit booms build before 2008. Many central banks now pair inflation targeting with macroprudential regulation.
- The zero lower bound. A 2% target leaves limited room to cut rates before hitting the zero lower bound (ZLB). Some economists, including Olivier Blanchard, have suggested a higher target such as 3% or 4%; others warn this would weaken credibility.
- Supply shocks. Responding to oil or food price shocks by tightening can hurt output, a particular issue in emerging markets where food is a large share of the basket.
- The 2021–2023 surge. Most targeting central banks let inflation rise far above target before acting, which critics saw as a failure of forecasting and judgement; supporters note that inflation then fell without the deep recessions of the 1980s.
- Alternatives. Some economists favour targeting the level of nominal GDP or the price level instead of the inflation rate, arguing that these would provide automatic "make-up" after shortfalls.
Policy-rate decisions under inflation targeting are often compared with the prescriptions of the Taylor rule, which links the rate to the gap between inflation and target and to the output gap.