The institutional framework for inflation targeting

The MNB’s primary statutory objective is to achieve and maintain price stability. To this end, it has adopted an inflation targeting framework for monetary policy since the summer of 2001. Under an inflation targeting framework, the central bank strives to meet a publicly announced inflation target using the monetary policy instruments at its disposal. Transparency and accountability of monetary policy are two important features of an inflation targeting regime.

The MNB can meet its inflation target by changing the central bank base rate to an appropriate extent and pace. In Hungary, setting the key policy rate is the responsibility of the Monetary Council, the MNB’s supreme decision-making body. The Council convenes as required by circumstances, usually twice but at least once a month, according to a pre-announced schedule. From the meetings one is a rate-setting meeting each month. The Council sets interest rates by a simple majority vote of members present. In the event of a tie, the Governor of the MNB has a casting vote. In case the Governor is prevented from voting, the Deputy Governor has a casting vote. The Council issues a statement explaining the reasons behind its action on the day of the interest rate decision. Abridged minutes of the Council’s rate-setting meetings are released regularly, before the next rate-setting meeting takes place. The aim of the minutes is to lend higher transparency to the monetary policy decision-making process and provide economic agents with a deeper insight into the Council’s evaluation of current economic conditions. Publishing the individual votes makes decision-makers accountable in respect of their contribution to the fulfilment of the mandate of price stability defined by Parliament.

An important component of the inflation targeting regime and monetary policy decision-making is a quarterly inflation projection prepared by the MNB staff and published in the Inflation Report. The underlying function of inflation projections is to contribute to the monetary policy decision-making process. The projections are based on an endogenous monetary policy assumption. This means that the projected macroeconomic path contains the feedback from monetary policy reacting to inflation and developments in the real economy.

In taking its policy decisions, the Monetary Council takes into account the baseline path of the MNB staff's projection, the uncertainty around it and risk scenarios that are jugded to be relevant.  However, decision-making is not a mechanical exercise, as the Monetary Council may give consideration to other aspects, in addition to the MNB staff's projection. 

How changes in the base rate affect inflation – the monetary policy transmission mechanism

A change in the policy rate can influence future developments in inflation via various channels of monetary transmission, the three most important of which are the interest rate channel, the exchange rate channel and the expectations channel.

The interest rate channel captures the process whereby a certain level of the central bank base rate influences interest rates on forint-denominated bank loans, and so it affects economic agents’ consumption and investment behaviour, i.e. the demand for goods and services. By lowering the base rate, the Bank can stimulate demand relative to the capacities of the economy determined by supply factors, and, ultimately, it contributes to the build-up of inflationary pressure. Conversely, raising the base rate can have the opposite effect.

Inflation developments may also be influenced through the exchange rate channel. An increase (reduction) in the base rate generates capital inflows (outflows), assuming that investors’ perceptions of risk are unchanged. That, in turn, strengthens (weakens) the exchange rate of the forint vis-a-vis the euro. A shift in the exchange rate influences inflation from the demand side through net trade, on the one hand, and it directly affects the prices of imported goods expressed in forint terms, on the other.

The expectations channel has a key role in modern central banking. One explanation for this is that it is not only the central bank’s current interest rate decisions, but also its expected behaviour, which may influence developments in the real economy and inflation. If the central bank has a sufficiently credible commitment to price stability, then economic agents will take their price and wage-setting decisions in the expectation that it is the central bank’s target which will drive the medium-term outlook for inflation. In this case, inflation expectations are said to be ‘anchored’, which is indispensable for maintaining price stability and makes it much easier for the central bank to bring inflation back to target, should an adverse shock occur.

Monetary policy has its full effect on the macroeconomy through the channels discussed above with a lag. The strength and persistence of the impact on inflation also depend on the nature of the shock that causes inflation to deviate from the inflation target. For this reason, the Monetary Council makes decisions on interest rates in a forward-looking manner, taking account of likely future developments in inflation over the following 5–8 quarters.

Given that monetary policy decisions have a relatively weak effect on inflation over a period of less than one year, offsetting certain one-off shocks to the inflation rate may involve excessively high real economic costs. For this reason, if such shocks do not materially influence the longer-term outlook for inflation, the MNB chooses a path for interest rates that does not offset the direct inflationary impact. However, ensuring that inflation expectations are firmly anchored in the face of temporary shocks is also of key importance, and therefore, in such cases the central bank will make efforts to rein in second-round effects.

Inflation targeting in Hungary

Hungary adopted the inflation targeting regime in June 2001, with the targets set for December 2001 and December 2002. Subsequently, the inflation targets were set on a yearly basis up to the end of 2006, for at least two years ahead. In August 2005, the Bank adopted an explicit medium-term inflation target for the period starting in 2007, defined as a 3 per cent rate of increase in the Consumer Price Index published by the Central Statistical Office. 

Table 1 Inflation targets

Target rates

Reference period

Date adopted


December 2001

June 2001


December 2002

June 2001


December 2003

December 2001


December 2004

October 2002


December 2005

October 2003


December 2006

November 2004



August 2005

 3 % ±1percentage point


 March 2015


According to common practice among central banks that have adopted the medium-term continuous inflation targeting regime, the target is not set for an unspecified period of time, rather it is revised after a certain period, mostly after 3–5 years. The MNB has decided that the medium-term inflation target will be reviewed at the time of Hungary’s entry into the European exchange rate mechanism (ERM II), but within 3 years at the latest after the target has been set. These reviews maintained the medium-term inflation target at 3 per cent, while a ±1 percentage point tolerance band has been designated around the inflation target in 2015. The ex ante tolerance band represents that the inflation may fluctuate around the point target as an effect of shocks impacting the economy. The Bank assesses its performance in meeting the inflation target on an annual basis in its Annual Report.