Concent of inflation targetting , point out clearly advantages and disavantages of the policy

Question

by CBN

Answer 1

Inflation targeting is a monetary policy in which a central bank attempts to keep inflation in a declared target range —typically by adjusting interest rates. The theory is that inflation is an indication of growth in money supply and adjusting interest rates will increase or decrease money supply and therefore inflation.

Because interest rates and the inflation rate tend to be inversely related, and due to the projected or declared rate being publicly known, the likely moves of the central bank to raise or lower interest rates become more transparent. Examples:

    * if inflation appears to be above the target, the bank is likely to raise interest rates. This usually (but not always) has the effect over time of cooling the economy and bringing down inflation.

    * if inflation appears to be below the target, the bank is likely to lower interest rates. This usually (again, not always) has the effect over time of accelerating the economy and raising inflation.

Under the policy, investors know what the central bank considers the target inflation rate to be and therefore may more easily factor in likely interest rate changes in their investment choices. This is viewed by inflation targeters as leading to increased economic stability.