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The central banks’ inflation target of 2% will be judged after the pandemic.

Top central bankers say that using a 2% inflation target has helped keep prices stable for decades. This is the first real test of how well this approach to monetary policy works once prices have exploded, and how strictly they’ll enforce it if the damage to their economies gets worse.

By setting a goal for inflation, central bankers think they build their own credibility and help households and businesses plan in ways that help keep inflation in check. It was a theory that seemed to be backed up by the facts as inflation targeting spread from New Zealand in 1990 to Europe and then to the US and Japan in 2012 and 2013.

Up until the end of the first year of the coronavirus pandemic in 2020, inflation was mostly kept in check during these decades.

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But they also happened at the same time as changes in globalisation, technology, and population that were helpful. Since the start of the pandemic and continuing with Russia’s invasion of Ukraine, the same forces may now be pushing prices in the opposite direction. This presents the shared monetary policy framework with a problem it has never seen before and may find difficult to address due to ongoing supply shocks.

“In the future, inflation may be more likely to stay high than it has been for the past 20 years.” “The effect of localization on deflation is fading, and inflationary pressures will come from global trade, climate change, population growth, and politics.” Claudio Boric, who is in charge of the Bank for International Settlements’s money and economy department, said this. The Bank for International Settlements is a group for central banks.

But Borio said he didn’t like the idea of raising the central banks’ inflation targets. This is a view that has become popular among top policymakers, from “hawks” to “doves,” despite concerns that the recent rise in inflation may last longer than expected and make it harder to get back to 2%.

At least for now, central bankers are more worried about losing their credibility if they don’t stick to the line they set.

“Is 2% kind of like a magic number?” Lael Brainard, vice chair of the U.S. Federal Reserve, said this at a meeting earlier this month. “Most likely not.” But it’s our number, and we’re very committed to getting inflation back to 2%. “Getting to that goal is central to our monetary policy as a whole.” Brainard said this, and the heads of central banks from Frankfurt to London to Tokyo all agreed.

Last year, Bank of England Governor Andrew Bailey said, “Let me be clear: There are no ifs or buts about our commitment to the 2% inflation target.” “That’s our job, and we’re going to do it.”

The race to raise rates can be seen in this chart from Reuters:


As it has done every year since 2012, the Fed is expected to recommit to 2% inflation at its two-day policy meeting this week. This is the rate that is “most consistent over the longer term with the Federal Reserve’s statutory mandate” from the U.S. Congress to promote “stable prices” and maximum employment.

Even though the U.S. central bank has made major changes to its “Statement on Long-Run Goals and Monetary Policy Strategy,” it has never put the inflation target itself up for grabs because a promise is a promise and can only be renegotiated at great risk.

Still, Brainard said that the 2% number doesn’t mean much by itself. Even though it’s now the standard around the world, it wasn’t based on a lot of research or statistics. Instead, it was a best guess about an inflation rate that would give the central banks the benefits they see in setting a target while still being low enough that the public wouldn’t notice.

Coming out of the high inflation of the 1970s and 1980s, policymakers knew they needed to build their credibility in fighting inflation. They saw announcing an inflation target as an easy way to set public expectations and, if they kept to it, build trust.

At the same time, they wanted an inflation rate that was in line with long-term price stability, which was defined by former Fed Chair Alan Greenspan in a debate in the mid-1990s as “a state in which expected changes in the general price level do not change business or household decisions in a meaningful way.”

Even though some “inflation hawks” still say that the level should be zero, most people agree that prices going up by a small amount is good for an economy. It gives firms a way to adjust “real” labour costs without curbing hiring, and it gives central banks more room, through higher nominal interest rates, to manage economic downturns with interest rate cuts rather than bond purchases and other less conventional measures used once policy rates hit the zero or near-zero level.

In the 1980s, politicians in New Zealand put pressure on government officials to do something about the country’s high inflation. They were the first to try out this idea by setting an initial goal between 0% and 2%.

An economist who used to work for the Reserve Bank of New Zealand said, “It wasn’t the most scientific process in the world.” “We were the first ones to do this.”


Still, it stuck. It got out. It may have helped, too.

The president of the New York Fed, John Williams, said earlier this month, “I think that number made sense based on all the history, experience, and research.” It has served us very well. “This has helped make things clear.” It helps the markets and people understand what our North Star is.

The question that hasn’t been answered yet, though, is what will happen if the North Star turns out to be less of a goal and more of a symbol that can’t be reached—if the path back to 2%, which was already expected to be slow, stops in the economy after the pandemic.

Graphic: Inflation is still higher than expected everywhere.

Economists and people who make policy don’t think inflation will go down quickly and in a straight line. Some people even think that the current phase is the easy part, since everyone agrees that interest rates need to go up and inflation is starting to slow down without doing any serious damage to the job market.

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Policymakers say they’ll get that last bit of inflation back to where they want it to be.

But even though they are focused on getting inflation back to 2%, they have also said that the debate could get more complicated as they watch how inflation and the economy respond to the interest rate hikes that have already been approved and the ones that are coming up.

Brainard said that the quick rate hikes last year were important to show that the Fed was serious and to make sure people knew that 2% inflation was still the right target. “We’re in a bit of a different place now… “We are now in a place where we have to weigh risks on both sides.”

Fed officials say that their efforts to tighten things up could cost 1.5 million jobs in the United States this year. If inflation sticks around longer than expected, the central bank’s goal of 2% inflation could cause even more losses.

Brainard said, “It is a very uncertain environment, and you just can’t rule out worse trade-offs,” even though recent data shows “slightly better prospects” for an outcome in which inflation slows to target without causing major damage to employment or economic growth.

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