The Pathetic Reason for Our 2% Inflation Target

Seven Bad IdeasEven if focusing almost solely on maintaining low, stable inflation made complete sense, why such a low rate of inflation? Persuasive studies find that only annual rates of inflation into the double digits affect economic growth. Moderate levels of inflation of well more than 2 percent show little appreciable damage. Some economists make a strong case that an inflation target closer to 3 percent would have been more beneficial to the United States. Few paid attention to this research, which seemed like a radical notion, a mere one percentage point rise in the target.

As far back as 1988, Alan Greenspan told Congress that the rate of inflation should be low enough that “households and businesses in making their saving and investment decisions can safely ignore the possibility of sustained, generalized price increases or decreases.” In 1996, he told his Federal Open Market Committee, the group of Federal Reserve governors and regional bank presidents who set monetary policy, that the rate should be close to zero. But Greenspan settled for a 2 percent target because the inflation data collected by the Bureau of Labor Statistics overstated, he thought, the rate by a percentage point or more. The informal target of 2 percent annual inflation, as measured by the consumer price index, was therefore really closer to zero already.

—Jeff Madrick
Seven Bad Ideas

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