Price Level Targeting

Ready...aim...fire! Ah, a near miss on that price level target. Try again, Fed.

Central banks, such as the Federal Reserve in the U.S., oftentimes try to hit a certain price level via price level targeting. These banks tinker with monetary policy, doing things like raising or lowering interest rates as if they're economic demigods to keep inflation at an ideal rate. Of course, ideal inflation rates are subjective, but in general: hyperinflation is bad, and low, stable inflation is considered good.

When there’s a lot of inflation, it means prices are going up, up, up. If they keep going up, people will eventually stop taking this whole “money” thing seriously. "Bread cost me $3 last week, and now it costs $500? Psshh, I might as well use my $3 for toilet paper."

A little inflation is all right, since that’s just the economy growing. Growth means more money in the system, which means more demand for things, which raises prices.

Central banks use price level targeting as a way to keep the economy growing, but at a stable pace; nobody wants hyperinflation. A nice inflation number? Around 2% per year. If inflation falls below that, the Fed might lower interest rates, encouraging borrowing and spending. If inflation is above 2%, the Fed might raise interest rates, making stuff more expensive so that the price level stops rising so much.

Targeting prices to affect inflation (rather than targeting inflation directly) is easier for central banks, because they can see various baskets of goods changing prices. But that also makes it riskier, since if they’re focusing on one basket of goods and not others, they could end up amplifying the business cycle rather than tempering it. It can get politically messy too, depending on which basket of goods you decide to use for price level targeting. For these reasons, price level targeting is kind of...out of vogue.

See: Price Level.