For nearly two years, as pandemic-induced inflation has rippled through the economy, we've heard Fed officials say, repeatedly, that the central bank is committed to stabilizing prices at around 2%.
Not 3%. Not 1%. Always 2%.
But what's so special about 2%? Why has the Fed been so focused on hitting that target?
The answer is surprisingly arbitrary.
A quick history lesson: Three decades ago, inflation targeting wasn't really a thing. But a bunch of policy wonks over in New Zealand were trying to figure out how to bring double-digit inflation under control. One day, the finance minister went on TV and just told everyone there was a new target.
"It was a bit of a shock to everyone, I think," Roger Douglas, the Labour Party finance minister, told Reuters' Lucy Craymer earlier this year. "I just announced it was gonna be 2%, and it sort of stuck."
The 2% target became all the rage among central banks.
Economists and policy makers began to see it as the sweet spot for inflation — a positive but low level that signals an economy is growing, but not so fast that it's straining consumers. It became engrained in US economic policy by the mid-90s, though it wasn't formally announced as a target for the Fed until 2012, under Chairman Ben Bernanke.
Of course, econ wonks have continued to argue about it. Some have argued that 0% ought to be the goal. Others say 4%.
"Two percent is kind of a compromise," Josh Bivens, research director and chief economist at the Economic Policy Institute, told me. "It's for the people who thought there should be some positive but low inflation. And then for the people who want pure price stability, or 0% inflation — 2% is almost a measurement error."
Arbitrary, yes. But effective.
The result of low inflation over the long term has been that most people don't really think about it. It's like that parable about two young fish who swim past an older fish who says, "Morning, boys, how's the water?" And the young fish asks his friend, "What the hell is water?"
Of course, by 2021, the water was getting too hot, and everyone felt it. After decades of barely perceptible inflation, prices spiked, peaking at 9% year-over-year in June last year. That's renewed some debate about the merits of the 2% target and whether it's time to move the goal posts — something Fed officials aren't considering at this time.
On Tuesday, New York Fed President John Williams was asked about the inflation target at an event.
"The 2%, target I don't view as arbitrary ... One of the things we realize from both experience in the US and around the world is that high and variable inflation undermines the ability to achieve maximum employment and the economy's potential overtime. Countries that have high variable inflation do worse in terms of economic performance."
Look ahead: On Wednesday, the government will release the Consumer Price Index reading for April, a closely watched measure of inflation. The headline CPI figure has been trending steadily down for nearly 10 months.
Economists expect the report to show that consumer prices rose 5% year-over-year in April — unchanged from March, and much higher than the Fed's target. The Fed doesn't watch CPI nearly as closely as its favorite Personal Consumption Expenditures index, which provides a more complete picture of costs for consumers. But PCE is also more than double the Fed's 2% target.
Bottom line: The Fed's not budging on 2%, and it'll keep using the most powerful tool in its arsenal — interest rates — to force inflation back to that low-and-slow simmer.
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