Is the Fed’s 2% inflation target too high or too low? That’s the big debate now amongst central bankers.
The Wall Street Journal reports Policy Makers Rethink a 2% Inflation Target.
From Ottawa to Oslo, policy makers have been considering whether that level of consumer-price growth, a Holy Grail for the world’s major central banks over the past quarter-century, is still relevant.
The 2% target was always an arbitrary figure, some economists argue, and even if it was optimal two decades ago, that is no longer the case given deep changes that have since reshaped the global economy.
Trouble is, it isn’t clear what inflation rate would be better. Dozens of academic studies that considered that question have produced answers ranging from 6% to less than zero, according to a survey published last year by Federal Reserve economist Anthony M. Diercks.
“Whatever [inflation] rate was thought to be optimal in 2006 or before is now too low,” says Olivier Blanchard, a senior fellow at the Peterson Institute for International Economics in Washington, D.C., who has called for a 4% target.
Factors such as aging populations, low economic growth and higher savings rates are working to push down the neutral interest rate, at which the economy is growing at a sustainable rate for the long run and inflation is stable. As a result, central banks run a greater risk of taking benchmark interest rates to zero or below when seeking to support growth.
Demographics
Logic would dictate that if demographics work to hold the inflation target lower, then the target ought to be lower, not higher.
Lesson from Japan, ECB
Japan provides ample evidence of what happens to savers when the central bank holds down rates hoping for higher inflation. All Japan did was accumulate debt. Inflation went nowhere.
What good does it do to set a target when you struggle for decades in the case of Japan and one decade in the case of the ECB to hit your target?
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