Explain the concept of inflation targeting and its relationship with the CPI.

Inflation targeting is a monetary policy strategy adopted by central banks to maintain price stability in an economy. The primary objective of inflation targeting is to keep inflation within a specific target range over a certain period of time. This strategy involves the central bank setting a specific inflation target, typically expressed as a percentage, and using various policy tools to achieve and maintain that target.

The Consumer Price Index (CPI) plays a crucial role in the implementation of inflation targeting. The CPI is a measure of the average price level of a basket of goods and services consumed by households. It tracks changes in the prices of a wide range of goods and services, including food, housing, transportation, and healthcare. As such, it provides a comprehensive measure of inflation in an economy.

Central banks use the CPI as a key indicator to monitor and assess the inflationary pressures in the economy. By comparing the actual CPI with the inflation target, central banks can determine whether the economy is experiencing inflationary or deflationary pressures. If the CPI exceeds the target, it suggests that inflation is too high, and the central bank may implement contractionary monetary policies, such as raising interest rates or reducing the money supply, to curb inflationary pressures. Conversely, if the CPI falls below the target, it indicates that inflation is too low, and the central bank may adopt expansionary monetary policies, such as lowering interest rates or increasing the money supply, to stimulate economic growth and raise inflation.

Inflation targeting and the CPI are closely intertwined as the CPI serves as a guide for central banks to make informed decisions regarding monetary policy. By targeting a specific inflation rate, central banks aim to anchor inflation expectations and promote price stability, which is crucial for sustainable economic growth. The CPI provides the necessary data and information to assess the current inflation situation and guide the central bank's actions in achieving their inflation target.