What it means
Under inflation targeting, the central bank aims for, say, 2 percent inflation this year, and whatever happened last year is water under the bridge. Misses are forgiven and forgotten.
Price-level targeting refuses to forget. If inflation runs at 1 percent for two years, the price level has fallen below its target path, and the bank must deliberately run inflation above 2 percent to catch back up.
The Bank of Canada's research review of price-level targeting, written during its framework renewal process, defines the contrast exactly this way: inflation targeting permits price-level drift, while price-level targeting offsets shocks so the price level returns to its path. The theoretical appeal is powerful: if everyone believes misses will be reversed, expectations anchor harder.
A shock that pushes prices down generates expectations of future catch-up inflation, which lowers real interest rates and stimulates the economy automatically, a built-in stabiliser. That same logic is the risk.
If the public doubts the bank will really deliver catch-up inflation, or fears it, the policy loses its magic, and engineering deliberate above-target inflation is precisely what central banks find hardest. No major central bank has adopted it outright, though Sweden's Riksbank targeted the price level in the 1930s, and the Federal Reserve's 2020 shift to average inflation targeting borrowed some of its make-up logic.
The framework keeps resurfacing after every long stretch of low inflation, because its core promise, long-run price predictability, addresses the deepest weakness of annual inflation targeting: the compounding of misses. For a non-finance reader, the distinction is about memory: inflation targeting has none, while price-level targeting keeps a ledger and promises to settle it, which changes what everyone expects tomorrow.
Critics worry about the overshoot years. Deliberately running hot after a slump asks the public to trust a promise that looks, in the moment, like losing control of inflation, and trust once lost is expensive to rebuild.
The framework also complicates communication. Explaining that this year's 4 percent is success, not failure, is a harder message than hitting a simple annual number, and central banking runs on messages.
In practice
Real-world examples.
Example
After a year of 0.5% inflation against a 2% path, the price level is about 1.5% below its path (100.5 against 102). A price-level-targeting bank commits to above-target inflation until the gap closes. The commitment does some of the easing before any rate moves, because lenders and borrowers expect higher inflation ahead.
Example
The Federal Reserve's 2020 framework of averaging 2% inflation over time borrows make-up logic from price-level targeting without the full commitment. After a period below 2% it is willing to let inflation run somewhat above. It stops short of promising to return the price level to a fixed path.
Example
Sweden's interwar price-level target is cited in research reviews as the closest historical precedent for the framework. The Riksbank targeted the price level in the 1930s. Modern central banks study that episode when they weigh make-up strategies.
Formula
Calculation
Target price level in year n = base price level x (1 + target inflation rate) raised to the power n. Required catch-up = target path level - actual price level.
Worked example. A made-up central bank sets a 2% path from a base index of 100.
- The path is 102 after year 1 and 104.04 after year 2 (100 x 1.02 x 1.02).
- If actual prices stay flat at 100 for those two years, the shortfall is 104.04 - 100 = 4.04 index points, or about 3.9% of the path (4.04 / 104.04).
- The path at year 4 is 100 x 1.02 x 1.02 x 1.02 x 1.02 = 108.24, so to catch up within two more years the price level must rise from 100 to 108.24, which needs about 4.04% inflation a year because 1.0404 x 1.0404 is about 1.0824.
- Under plain inflation targeting the bank would aim for only 2% a year, ending year 4 at 104.04, permanently about 4.04 points below the old path.Case study
Seen in the real world.
This case study is fictional and illustrative. A made-up central bank targets a price level rising 2 percent a year. A recession drags inflation to zero for two years, leaving the price level about 4 percent below path. Under its framework, the bank must now aim for roughly 4 percent inflation for two years, or 3 percent for four, to return to the path.
Markets that believe the promise do the bank's work: expecting catch-up inflation, traders push long-term real rates down immediately, easing conditions during the recession itself. The bank's governor spends half her speeches defending the framework's credibility, because everything rests on the public believing the catch-up will actually be allowed. Fifteen years later, historians credit the regime with shallower recessions, while noting it survived only because the bank tolerated the overshoot years that inflation targeting would have treated as failure.
Watch out
Common mistakes.
- Confusing price-level targeting with inflation targeting; the first reverses past misses, the second forgives them, and that difference changes expectations entirely.
- Assuming the make-up stimulus works automatically; it depends on the public believing the central bank will deliver and tolerate future overshoots.
- Claiming major central banks use it today; none has fully adopted it, though several frameworks borrow its make-up features.
Questions
People also ask.
What is price-level targeting?
A monetary framework where the central bank targets a rising path for the price level itself, offsetting past misses instead of resetting the inflation goal each year.
How does it differ from inflation targeting?
Inflation targeting lets bygones be bygones, creating price-level drift; price-level targeting requires catching back up to the path after undershoots or overshoots.
Has anyone used it?
Sweden's Riksbank in the 1930s is the classic case; modern central banks have studied it intensively, and some, like the Fed since 2020, use softened make-up variants.
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