Lesson 4 of 8 · 14 min
Effective central banks and inflation targeting
An effective central bank is independent, credible and transparent; inflation targeting builds on those three qualities by promising a clear, forward-looking inflation goal, usually about 2%.
In short
- Three qualities make a central bank effective: independence, credibility and transparency.
- Operational independence: the bank sets interest rates. Target independence: it also chooses the inflation measure, level and horizon.
- Credibility matters because a believed target becomes self-fulfilling: expectations feed into wages and prices.
- Transparency (inflation reports, clear explanations) builds credibility and makes expectations easier to anchor.
- Typical target: about 2% CPI inflation with a band of about ±1 point, aimed at inflation about two years ahead. Not 0% (deflation risk) and not much higher (volatile, uncertain inflation).
- Two prominent central banks without a formal New-Zealand-style target: the Bank of Japan (long fight against deflation) and the US Federal Reserve (dual mandate; about 2% core PCE seen as stable prices).
Unlock this lesson free for 7 days
Create a free account to get 7 days of full access — every lesson, video, flashcard, mock and the question bank. No card needed.