Daily Open The Fed wants 2 inflation But the economy

Daily Open: The Fed wants 2% inflation. But the economy could be fine with higher inflation

The Marriner S. Eccles Federal Reserve Building in Washington, DC

Stefanie Reynolds | Creative photos by Bloomberg | Getty Images

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The Fed wants to push inflation down to 2%. But the economy could be fine with higher inflation.

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  • The US Federal Reserve – and many other central banks around the world – have announced their determination to bring inflation down to 2%. But this 2% target is relatively arbitrary.
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The 2% inflation target has been repeated so many times by Fed officials and central bankers around the world that it seems absolutely crucial to a healthy economy. But “the 2% inflation target is relatively arbitrary,” said Josh Bivens, research director at the Economic Policy Institute.

In fact, it was invented in New Zealand in the 1980s. Arthur Grimes, professor of well-being and public policy at Victoria University, said that New Zealand was experiencing skyrocketing inflation at the time and the central bank chose – seemingly out of nowhere – an inflation target so it could work towards a target.

Other central banks followed suit. In 1991, Canada announced its inflation target; the UK followed a year later. It wasn’t until 2012 that the US declared its inflation target of 2%, but since then that figure has stubbornly stayed alive in the Fed’s mind.

But if the 2% target is arbitrary, it means that the economy could function normally at a higher level of inflation. In fact, some economists wrote a letter to the Fed in 2007 advocating a higher ceiling. “There is no evidence that inflation of 3 or 4% compared to inflation of 2% does any significant harm,” said Laurence Ball, an economics professor at Johns Hopkins University who was one of the signatories to the letter.

However, the Fed is unlikely to change its target midway through the current cycle of rate hikes – it could look like giving in to investor demands for lower rates. Rethinking what healthy inflation means will be a task left to another generation of central bankers.

– CNBC’s Andrea Miller contributed to this report.

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