Yellen supposedly told Greenspan & co in the mid 90s that 2% was a good way for companies to be able to adjust labor costs down if needed (if you don't give someone a raise when inflation is 2%, you're effectively lowering their salary). It was the only way to have some flexibility there. If you admit that this is a desirable thing, this is defeated by wage negotiations (or say, benefits) than tend to be indexed to inflation.<p>Another interesting thing that happened under Greenspan is how inflation is computed (hedonics, replacements, etc... conceptually, think "if I can't buy a porterhouse steak anymore, I'll get the lesser hanger", meaning inflation is underreported). I'm not suggesting this was intentional or coordinated, but this had the huge benefit for federal and local governments that it lowered the benefits they had to pay out that were linked to inflation. Issue is it hurts the poor more.
The more money the banks print, the richer they get, with the side-effect that prices rise (they make the monetary units less scarce and worth less).<p>2-3% just happens to be the most they can get away with in the long term without the population getting concerned.<p>What the general population don't realise is that the value of goods and services are going down over time, due to efficiency increases, at a rate of around 5% / year. The banks can print enough money to soak that up unnoticed, and then an extra 2% just because they can. It's essentially a stealth transfer of wealth from the people to the banks and it's been going on for decades/centuries (before fiat, it used to take the form of coin shaving, impure metals etc).<p>You really see the effect when you look at house prices. They are roughly the same price in gold as they were in the 1970s. Rather than housing going up in value since then, it has been the monetary units going down in value, due to the supply roughly doubling every decade (look up M2 USD).<p>You can understand the incentive to print money when you realise that every year the banks are collecting interest on every dollar/euro/pound etc. in existence. And the banks don't really own any of them - they printed them out of thin air as loans and have to destroy them when the loans are repaid, but total debt only increases every year...
I was taught two reasons in undergrad Econ;<p>1) Deflation is seen as much worse, because inflation encourages spending over saving, which drives growth. Targeting, e.g. 0.5% risks missing and going negative.<p>2) Inflation reduces the true value (cost) of debt. And with $34.5 trillion of it, that’s a big incentive to keep it around.<p>IMO 2% is clearly too high of a target, but it’s the hamster wheel that makes everyone keep running so not surprising that government spins it too fast.
There are significant stabilization benefits to having a public (and binding) inflation target - all of the large economic entities / sectors like banking, government spending, corporations, etc., become more predictable to each other. For this reason, whatever number is chosen will tend to “stick”, regardless of how the actual number is chosen. Or alternatively: it is optimal to have an inflation target (compared to not having one). Once you are in the “targeted” space, there is a further optimization of deciding what the inflation target should specifically be, but the gains and losses here are small compared to the existence or lack thereof of any target at all.
> Once the bill became law, then an inflation target had to be chosen. In an off-hand remark in an interview, the former head central banker said the inflation target should be zero to 1 percent. However, Don Brash, the head of the central bank, claimed “It was almost a chance remark,” and “The figure was plucked out of the air to influence the public’s expectations ”(Irwin, 2014). They used this number as a starting point and pushed it up to 2% to give themselves a bit more room<p>This feels like so many decisions we make day-to-day in STEM. We all love to feel like we have quantitative reasoning behind decisions but due to the organic nature of the work at some point, we just have to land on _something_ and go from there. Like qualitatively-influenced quantitative data.
Paul Krugman covers that question here (gift link): <a href="https://www.nytimes.com/2023/06/09/opinion/inflation-target-2-percent.html?unlocked_article_code=1.ek0.979y.zLAO6U1LWn88&smid=url-share" rel="nofollow">https://www.nytimes.com/2023/06/09/opinion/inflation-target-...</a> and argues that the theoretical assumptions that led to the 2 percent rate didn’t turn out to be true:<p>> On one side were economists who believed that the essential role of monetary policy — maybe even its moral duty — was to deliver stable prices. Money, after all, is a yardstick we use to measure economic activity, and they argued that this yardstick shouldn’t be constantly changing its length.<p>> On the other side were economists who worried that too low an inflation rate could inhibit our ability to fight recessions. The Federal Reserve and its counterparts in other countries try to manage the economy mainly through their control of short-term interest rates; but these rates can’t go much below zero, because negative rates would just lead people to accumulate stacks of $100 bills. A higher rate of inflation tends, other things being equal, to raise interest rates and makes it less likely that the Fed, faced with a recession, will hit the “zero lower bound” and be unable to cut rates further.<p>The zero lower bound turned out to be a real problem, given the amount of years we spent at a zero percent interest rate.
Many things in life are like this; for instance, (from back in the days when we worked in offices) it's much more important that a group who wants to go out to lunch together all agree on the same place than that place be the theoretically optimum lunch destination.
Higher inflation levels in the upcoming decades are effectively inevitable with the parabolic public debt levels and zero political appetite for reducing budget deficits. Things like quickly approaching insolvency of the Social Security program only make the situation worse. As soon as the public debt market (including repo) will see any issues the Fed will quickly ride to the rescue, inflation be damned. We've clearly seen it right before the pandemic and with UK gilts.<p>It does not matter what the inflation target is. It's likely we will see double digit inflation spikes with "hard work" of bringing it back to target levels (be it 2% or 4%), so on average you will get anything but the target level.<p>And before someone mentions Japan, read this: <a href="https://www.lynalden.com/economic-japanification" rel="nofollow">https://www.lynalden.com/economic-japanification</a>
> This would be problematic since people would not invest or spend money to get the country out of a recession when they could just get a return from doing nothing. Instead of taking a risk and investing the money, the velocity of money decreases, and there is less spending leading to higher unemployment and less growth.<p>> The story of the inflation target is one which is much more random and less thought through than you would expect.<p>Apart from that, the Japanese narrative is used as an argument but misses that Japan had a real-estate bubble and the burst of this bubble will force deflation. This is not a case of "deflation bad" but rather a re-adjustment of their local prices.<p>As an anecdote, in the latest crypto "deflation cycle", activity was up. Essentially, people used their extra purchasing power and bought goods. In fact, I'd argue that this is healthier. If you know the value of your money will go up, you'll hold up buying useless stuff freeing the capacity for somebody else. People will always buy stuff when they need the stuff.<p>On the other hand, inflation encourages unnecessary spending. You know your money will burn anyway, so you go ahead and spend it. This is bad because it de-allocates resources from people who might need them. A strong deflationary cycle will push certain capital to be spent again because it appreciated much: the economy has enough excess capacity that everything is on sale.<p>Of course the people who benefit from inflation will sell a different narrative. And of course the above is strictly my opinion.
> Once the central bank said that inflation would be 2%<p>This article is confusing. It makes it sound like NZ set a target of 2% inflation, when in actuality they set a target range of 0-2%, so 2% was the ceiling not the target.<p><a href="https://www.rba.gov.au/publications/confs/2018/mcdermott-williams.html" rel="nofollow">https://www.rba.gov.au/publications/confs/2018/mcdermott-wil...</a> figure 1 and table 1 makes it more clear.<p>Naturally central bankers have been happy to turn a ceiling into a target/floor.
I believe it is 2% because you can't ever let inflation get near zero, because deflation is devastating to an economy. (See: Great Depression). Interest rates, particularly for very safe investments like US bonds tend to be very close to what the long term inflation is expected to be. Like, not inflation this year, but the next five to ten years. That's why it's higher than the CPI when the CPI is very low and lower when it is high.<p>Everyone knows inflation is unpopular, so you want to keep it low.<p>The Fed may have to "cut interest rates" (they don't do that directly, but do things with money that have that effect) to improve economic growth, particularly if there is an external shock. They want to have some wiggle room to still be able to cut the interest rate without risking it getting to the dreaded deflationary zero rate. So they have 100- 150 points of stimulus to work with in an emergency.
>> This loss of trust is a major problem. For example, if you no longer believe the Fed inflation target, then you will base your actions on what you think the inflation rate will be, which can lead to cycles of inflation. If you believe inflation will be high soon, you will buy a lot of stuff now when prices are lower. However, other people will realize this too, and then there will be a race to buy goods and services, which will lead to less supply and higher prices. This creates more demand, which leads to higher prices, creating the inflationary doom loop. Showing that losing the Fed’s credibility may not be worth the benefit of a better target.<p>The FED is clearly in a damned if they do damned if they dont scenario. Blaming the target feels like a red herring. In the scenario they pitched would create demand and supply shocks in the short term but recession must and would is surely to follow because of the inefficiencies in the market. The real question is Who is in charge here? If the Fed was, they would and could get in front of inflation and raise rates to where inflation would not come back however, at the risk of upsetting markets, it seems they've been politicized into inaction.
It's really not that complicated: a little inflation is better for both the economy and the average person than a little deflation, and the tools available are clumsy enough that it's impossible to accurately target 0%. The end result is a target of just enough inflation to avoid deflation if the numbers swing around unexpectedly.
I would ask a different question. Why combine a bunch of prices into an opaque number and call it "inflation"?<p>I'd argue that doing so masks the true causes of price rises. Prices go up because companies make the choice to raise their prices. Sometimes this is because their own inputs became more expensive but in many more cases it's because the people running the company want to increase profits.<p>By hiding the choices made by people running companies behind this opaque number called "inflation" that people perceive as somehow controlled by the government we've allowed companies to get away with making decisions that increase profits for wealthy executives and shareholders at the expense of people who rely on the goods produced by the companies.
What is missing from the article (unless I missed it myself) is why inflation would be desirable in the first place.<p>There's probably a couple of reasons, some already discussed. Like lowering wages without actually lowering wages.<p>And inflation is a great tool for governments to "pay off" their debt.<p>But you have to keep the rate at a level low enough not to cause upheavals. Hence the rates of like 1% or 2%.
I have been thinking that with better and more frequent reporting of the statistics over the years that this inflation target of 2% could go to 1% if not zero.<p>In my mind, central banks and the all the levels of governments should be getting weekly (if not daily) reports of hiring, job losses, house building, and rental prices / turnovers in like a Grafana dashboard.
The current monetary system could essentially be swapped for Universal Basic Income.<p>If the reason 2% inflation exists is to increase money velocity then a fair distribution of money to everyone equally would accomplish exactly that and more.<p>What about loans? People would still keep their money in banks, which would make circulate in the economy only keeping 10%, just like now.
One way I've been told to understand this is that money is actually growing at around 6%, which is to say that money growth is highly inflationary.<p>Of course this is way too high, so to offset this there are deflationary measures, primarily increased productivity, technological improvements etc.<p>The problem with this is that we end up working permanently harder and it reaches a point of unsustainability. For example, now you generally need two incomes to sustain the same lifestyle as previously, because we need more people working etc.<p>Other deflationary measures included the opening of the Asian labor market, and then other globalisation measures.
I feel like it's the time of the year again to point to this website: <a href="https://wtfhappenedin1971.com" rel="nofollow">https://wtfhappenedin1971.com</a>
> Although the idea of a more valuable dollar may sound great, many economists think it is worse than high inflation (Engeman, 2019). The problem is that the value of money would increase when people do nothing with it. This would be problematic since people would not invest or spend money to get the country out of a recession when they could just get a return from doing nothing.<p>Yes, how terrible that would be.<p>In reality people would still need to buy things that are actually important.<p>Housing. Food. Heating. All kinds of stuff. And on top of that we are still gonna spend on the non-essentials as well. It’s not like I’m going to completely stop watching movies or playing games or listening to music just because I know my dollar today would be worth more tomorrow.<p>The people that would be holding back are the ones that have hoarded all the resources in the first place. And that’s the real problem. Inflation is a bandaid to avoid things getting as bad as they would. But the reason is because of people taking too much and societies that don’t take care of their people. Incidentally the ultra rich also have a lot of clever ways of avoiding being impacted by inflation in the way that it impacts most normal people.
If all the money becomes digital at some point, should we switch from inflation target to just automatically reducing every bank account balance by 0.005% per day (equivalent to 2% p.y.)
Rather than haggle about inflation/deflating I don't see people arguing that the govt should have any authority to dictate what medium of exchange people should use.
We need inflation because it's governments' only way to keep spending like crazy, at the expense of cash holders, who are often poor, and benefiting assets holders.
Incredible on such a macroscopic part of US monetary policy is a “Cloud Atlas” level special sensitivity to an off handed comment on the other side of the planet.
An interesting and little known fact is that New Zealand is often used as a beta test site. They had ATMs in the 70s because the kiwis act like westerners, but if things go wrong, nobody notices. Similarly computer based police databases. Hopefully they can show us how UBI works...
There's no point in defining a "target" when the Fed has no control over the vast portion of dollar creation/destruction: <a href="https://en.wikipedia.org/wiki/Eurodollar" rel="nofollow">https://en.wikipedia.org/wiki/Eurodollar</a>
The combination of monetary creation by the central bank to bring price inflation up to 2% combined with kayfabe austerity by the legislative/executive government is responsible for the utter hollowing out of our economy. The combo has given the centralized financial industry basically unlimited power to make highly leveraged investments for predictable things that conform to their pet models, while vacuuming real wealth away from the edges in the form of loan payments. A fundamental assumption of real working capitalism is that <i>capital is distributed</i>, and this combo has all but destroyed it.<p>Even if one insists on the orthodoxy that some price inflation is necessary, the new money to create such price inflation represents a distributed taking from our society (ie a tax), and thus should be spent for deliberate purposes by the government - ideally on infrastructure and other investments aimed at creating more wealth in the future - rather than being given to the financial industry as low interest loans to bid up the asset bubble out of the reach of main street. I believe this is the core of Modern Monetary Theory, and while poised to encourage a bit more spending than I would like from an Austrian perspective, it is at least honest compared to the past several decades of the Keynesian+Reaganomics bait, switch, and squeeze.
<i>"After all, no one likes it when prices rise."</i><p>Excuse me? One man or woman's "price" is another's "wage", and plenty of people like it when their wages go up.
Many economists and policy makers would agree that a rising tide lifts all boats. So if decreasing the real value of wages via inflation sounds counter intuitive and misguided, it's because it is.<p>The problem is capitalism only prizes selfishness. An individual (corporation) acts selfishly by paying the smallest amount to workers that it can get away with.<p>If wages rose with inflation there'd be more money for consumers to buy products, and all else being equal that is better for the economy (and corporations).<p>An environment where wages rise slower than inflation is a vicious cycle of workers having less money to allocate to goods, thus hurting demand, thus hurting wage growth, thus hurting demand, etc.<p>You might be tempted to think that these situations should even out over the long run. But that ignores the psychological effect that decreased purchasing power has on workers - making them more likely to be stingy with their money (spend less).
Inflation is entirely a monetary phenomenon. It is the result of the government creating money to fund the deficit. There's around a 13 month lag between the creation of the money and the inflation.<p>It's the Law of Supply & Demand in action. More money representing the value of goods & services in the economy means each dollar is worth correspondingly less.<p>The 2% inflation being "good" for the economy is propaganda.<p>The propaganda around inflation is amazingly effective. How often do you hear from otherwise intelligent and education people that inflation is caused by:<p>1. speculators<p>2. profiteers<p>3. greedy business<p>4. greedy unions<p>5. Putin's price hike<p>6. supply chain shocks<p>7. oil companies<p>8. Arab cartels<p>9. savers<p>10. banks<p>11. wage-price spiral<p>12. cost-push<p>13. demand-pull<p>It's all disinformation, and rather easy to refute. For example, if oil price hikes cause inflation, why do we not have corresponding deflation when oil prices go down?