A Project Report on Inflation Targeting: Should the Central Bank Get Into It?Economic Environment and PolicyTARGETING 'INFLATIONDefinitionThe inflation targeting framework refers to a set of economic policies adopted by the central bank in which it announces a projected or "target" inflation rate and strives to achieve this figure using measures such as as changes in interest rates and other monetary tools. Elements of inflation targeting[1] · Announcing an explicit quantitative inflation target or range for a certain period of time. clearly and unambiguously that its most crucial objective is to provide an environment with stable prices. · The central bank should have powerful models to make inflation forecasts. · The central bank must have a forward-looking operational procedure in which the definition of policy instruments depends on the evaluation. inflationary pressures and where inflation forecasts are used as the main intermediate objective. Prerequisites for inflation targeting[1] · The central bank should be able to conduct monetary policy with a certain degree of independence. · Absence of another targeted variable such as wages, employment level, or nominal exchange · Existence of a stable and predictable relationship between monetary policy instruments and the inflation rate. Issues in Implementing Inflation Targeting1. Situations of time inconsistency Situations of time inconsistency can arise because the central bank would try to reoptimize in the short term and lose sight of long-term objectives. The bank may start with a particular policy and then continue to modify it to meet certain short-term requirements. Such conduct would not have the desired effect. This effect can be explained using an inflation targeting model. [2]2p = pT-a(xu)p = inflationpT = target inflation percentagex= output gap (Y-Yn) / Ynu= fluctuationsa=l/aka= constant, k= measure of the cost of fluctuation of l 'inflationl= measure of the cost of fluctuation in production Consider a case where fluctuations, u=0. For a given value of “x”, the value of p would change if the value of a changes. If the central bank continually changes the importance it attaches to its objective of achieving a targeted inflation rate and maintaining a zero output gap, the value of a would vary and the achieved inflation rate would fluctuate continuously, causing thus errors in forecasting inflation2. Exchange rate volatility A study of exchange rate variability in countries that have adapted inflation targeting shows that although the variability decreased during the first 3 years of policy adoption, the coefficient of variation was enormous when considering the overall period. (Ref. Table 1). Such considerable currency depreciations would increase the dollar value.