Inflation targeting is a monetary policy regime oriented at setting and attaining an inflation target in the medium term. A distinguishing feature of this regime is to clearly define the monetary policy objectives and priorities thus fostering favorable expectations of the population and the market and increasing confidence in central bank credibility.
In an inflation targeting regime, an important role is devoted to the interest rate channel through which the central bank’s interest rate policy influences market rates with a further pass-through to the consumer, saving and investment behavior of the population and, eventually, to inflationary processes. The main instrument of the National Bank’s monetary policy is the base rate.
An inflation forecast where inflationary expectations of the population are taken into account is used as an intermediate target for the decision-making about the interest rate level. In case, if in the medium term the forecasted inflation exceeds its target, the central bank makes the decision to raise the existing level of the base rate, and vice versa.
A short-term interest rate in the money market is used as an operating target; generally, this is an overnight rate.