Target and actual inflation

Setting inflation targets

Inflation target is set by the NBS, in cooperation with the Government, based on the analysis of current and expected macroeconomic movements and the medium-term plan of changes in prices under direct or indirect regulation of the Government.

Inflation targets are set in advance in order to define the medium-term framework for monetary policy decision-making and to anchor inflation expectations. In the case of Serbia, inflation target is set for three years ahead until the process of nominal, real, and structural convergence to the EU is finished. As the process is ongoing, inflation target is slightly above the quantitative definition of price stability and the inflation target level in developed countries (2.0% or 2.5%). At end-2019, inflation target was set at 3.0% until December 2022, with a tolerance band of ± 1.5 pp (National Bank of Serbia’s Memorandum on Inflation Targets until 2022 was adopted at the meeting of the NBS Executive Board of 12 December 2019).

Measured as the annual percentage change in the Consumer Price Index, inflation target is set as a point value with a tolerance band. Inflation target is a precise and clear signal to the public of the inflation level that the central bank is trying to achieve. Also, the target is symmetrical which facilitates the central bank’s communication with the public in case of not only overshooting, but also undershooting the target.

The target tolerance band (± 1.5) indicates the acceptable room for inflation movements, taking into account that many temporary small-scale shocks can cause short-term volatility of inflation rate, without requiring a monetary policy response. It also reflects the commitment of the NBS to stabilise economic activity as it creates room for monetary policy flexibility without jeopardising its credibility.

Achieving inflation targets

The NBS strives to achieve the targeted rate of inflation by changing its key policy rate, i.e. the interest rate applied in the main open market operations. This interest rate is the key monetary policy instrument and the decisions on its level are based on the analysis of economic circumstances, assessment of future developments and the medium-term inflation projection. In setting the key policy rate, it is important to consider the lag effect, i.e. period between the moment when the rate is set and the moment when the effects on the ultimate goal, that is inflation, are felt, which in the case of Serbia is around one year.

Other monetary policy instruments play a supporting role – they contribute to the smooth transmission of the impact of the key policy rate on the market, as well as to the development of the financial market, without jeopardising financial stability.

The inflation target is a medium-term goal, which means that inflation can deviate from the target in the short term due to exogenous shocks. The NBS will allow temporary deviations from the target if bringing inflation back to the target in the short term warrants monetary changes that would cause disruptions to macroeconomic processes.

Target and actual inflation