Inflation Targeting

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DEFINITION of 'Inflation Targeting'

A central banking policy that revolves around meeting preset, publicly displayed targets for the annual rate of inflation. The benchmark used for inflation targeting is typically a price index of a basket of consumer goods, such as the Consumer Price Index (CPI) in the United States.

Along with inflation target rates and calendar dates to be used as performance measures, an inflation targeting policy may also have established steps that are to be taken depending on how much the actual inflation rate varies from the targeted level, such as cutting lending rates or adding liquidity to the economy.

BREAKING DOWN 'Inflation Targeting'

While the U.S. central bank doesn't typically have an explicit target for inflation (unlike other countries such as Canada, Australia and New Zealand), keeping inflation low is one of the Federal Reserve's primary concerns, along with stable growth in gross domestic product and low unemployment levels.

Inflation levels of 1-2% per year are generally considered acceptable (even desirable in some ways), while inflation rates greater than 3% represent a dangerous zone that could cause the currency to become devalued.

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