Inflation Targeting

Inflation targeting is an economic policy in which a central bank estimates and sets public a project inflation rate and then try to push the actual inflation towards the target by using interest rate changes and other monetary tools. As the interest rate and inflation rate are inversely related the likely moves of the central bank to raise or lower interest rates become more transparent under the policy of inflation targeting. The scenarios are. when inflation rates are above the target, the bank raises interest rates, this usually (but not always) affects overtime on cooling the economy and bringing down inflation. And the opposite, when inflation appears below the target, the bank lowers interest rates, this usually (again, not always) affects overtime on accelerating the economy and rising inflation.
The first country to adopt inflation targeting was New Zealand. Soon other countries also joined. The European Central Bank alludes to inflation targeting in its strategy statements, as do many countries in Eastern Europe that hope to join the European Union. Presently there is no country that has introduced inflation targeting and then abandoned it.
The central bank controls the inflation rate of the country, price shocks such as indirect taxes, commodity prices, or interest rates themselves are usually excluded in the calculation of inflation targets. There is also flexibility given in pursuing other goals like output stabilization through the commitment of the central bank to control inflation. The central bank is operating not against current inflation but for expected inflation in the near future. Inflation targeting rests on the following 3 foundations, first the provision of a nominal anchor for policy, transparency, and credibility. Second, a nominal anchor may be required if countries permit their exchange rates to vary and if they do not target either the growth of monetary quantities or nominal income. And third governments or their central banks may need such an anchor to stabilize inflation, and they can generate the anchor by announcing an inflation target and then doing what they must do to hit that target.