Target inflation

economic-dictionary

Target inflation is a term that refers to a strategy adopted in monetary policy. It consists of the central bank projecting a level of inflation that should not be exceeded, using different tools to meet the goal.

In other words, inflation targeting is a strategy used by central banks, given their monetary sovereignty. When they apply this strategy, what they do is analyze the economy and project a level of inflation that, as the name suggests, must be the objective and not be exceeded. In this way, they try to ensure that real inflation is always lower than or equal to the target.

To do this, the central bank makes use of instruments such as interest rates and increases or reductions in the money supply, for example, so that the inflation rate does not exceed the target established by the institution in question.

Taking into account that the main objective of central banks is price stability, they apply policies to guide inflation towards the established objective.

Characteristics of target inflation

Among the characteristics that define this system that can be adopted by any central bank, we must point out the following:

  • It is a strategy used in economic policy.
  • It is used or adopted by central banks.
  • It consists of establishing a target inflation level, which should not be exceeded.
  • Monetary policy instruments are used.
  • It aims to maintain a low and stable inflation rate.
  • The main objective of the central bank is usually to ensure price stability.

Principles of inflation targeting

If a country chooses this system, it should always bear in mind the following principles:

  • The central bank must contemplate the objective, and announce it for the short, medium and long term.
  • Likewise, when the central bank chooses this system, it assumes a commitment to society through which it guarantees and ensures that prices are stable.
  • Price stability in this strategy, therefore, is the main objective of economic policy.
  • There must be transparency, as well as communicating the strategies that will be followed and the plans that will be approved. This is to keep inflation low.
  • Likewise, the monetary authority assumes the responsibility of containing inflation, therefore, if it does not do so, it will not have fulfilled its mission.
  • Lastly, this being essential, the central bank must make the relevant tools available to the economy to maintain a low inflation rate that does not affect the economy.

Target inflation theory

Thus, the theory of inflation targeting shows that, by applying this scheme, countries can better control inflation, as well as achieve greater economic development. According to this theory, this strategy allows greater price stability and, with it, greater growth.

To this end, cases such as Brazil, Chile, Mexico, Poland or Peru are clear examples that this strategy, taking into account the empirical evidence, led the aforementioned countries to reduce their average levels of inflation. In both developed and undeveloped countries, the strategy worked.

Colombia, for example, at the request of the IMF, adopted this scheme after the 1998 crisis, being able to better control inflation and showing, once again, the success of this strategy.

In short, a proven strategy followed by the world's leading economies.

Inflation target example: Some countries

Among the many countries that use this scheme and are based on this strategy, we can highlight the following:

  • Europe.
  • USA.
  • Mexico.
  • Colombia.
  • Brazil.
  • Peru.
  • Chili.

All of these countries, as well as many others, use this strategy to set their economic policy.

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