Is the Fed’s 2% Inflation Target Too Low?

by Jon Hilsenrath
21-May (Wall Street Journal) — Central bankers around the developed world have agreed for much of the past two decades that 2% is a good objective for inflation. They want inflation to be low and stable, but they don’t want it too low. Interest rates move in line with inflation, and they don’t want inflation so low that interest rates are near zero. Then they would have no room to cut rates in a downturn to stimulate economic growth. Thus they have gravitated to 2%, a number born out of pragmatism more than any econometric model or proof.

Now, as with so much economic orthodoxy in this post-crisis era, people are starting to wonder if it’s the right number. Minutes of the Federal Reserve’s April 28-29 policy meeting, released Wednesday, shows officials debated whether the 2% objective is too low. One Fed official, unnamed as per tradition in the minutes, suggested the central bank should discuss raising it. In a higher inflation world, the Fed would have more room to maneuver with short-term interest rates, which have been pinned near zero since December 2008. It would have more room to respond if a new downturn were to emerge. It would allow the Fed to avoid another controversial bond buying program as an alternative to cutting rates.

This isn’t an entirely new idea. International Monetary Fund chief economist Olivier Blanchard floated the idea of a 4% inflation target in 2010.

[source]

PG View: They’ll never “officially” raise the target, but allowing an “overshoot” is another matter entirely.