Central banks have long stuck to the 2 per cent inflation target but now the conventional wisdom is being questionedby David Wessel / July 5, 2018 / Leave a comment
About a quarter century ago, central bankers around the world coalesced around a monetary policy strategy that was elegant in its simplicity. Although details vary, the world’s major central banks said they would aim to move interest rates to keep inflation at around 2 per cent. The theory was that setting such a target would promote economic stability and anchor public inflation expectations so that the central banks could, when necessary, tolerate a little more or a little less inflation without unsettling consumers, businesses or investors. It was, the International Monetary Fund has said, “a pragmatic response to the failure of other monetary policy regimes.”
New Zealand and Canada moved first. The Bank of England followed in 1992, and the European Central Bank did so in its infancy in 1998. Policymakers at the United States Federal Reserveprivately agreed to an inflation target of 2 per cent in 1996, but didn’t make it official—and public—until 2012. Inflation targeting at around 2 per cent worked reasonably well for a while. It was easy to communicate. It gave the public and politicians a yardstick against which to measure central bank performance. It helped bring inflation down around the world.
Today the wisdom of sticking to the 2 per cent inflation target is being questioned. With so much invested in the 2 per cent target no central bank is likely to move quickly to alter or replace it. But calls to rethink it have been proliferating, both from inside and outside the central banks, largely because of concerns that the current framework will make it uncomfortably difficult for central banks to fight the next recession.