FED NEEDS TO STOP CHASING THAT 2% INFLATION TARGET

If anything, Fed Chair Jerome Powell has been remarkably consistent about his commitment to driving inflation down to 2% annually.

To my knowledge, he has never publicly expressed any doubt about the wisdom of the Federal Reserve’s determination to hit the 2% target.

But, really, what’s up with the Fed’s apparent obsession with this 2% target? And, by the way, where does it come from?

THE ORIGIN OF THE 2% TARGET

Most folk would be surprised to find out that the much hyped 2% inflation target that the Fed is intent on hitting has its origins in an off the cuff remark made in 1988 by Roger Douglaus, who was New Zealand’s finance minister at the time (You heard that right: New Zealand’s finance minister). At the time, New Zealand, like the United States, was going through a period of high inflation; the inflation rate had dropped from a high of 15% to a “still too high 10%.”

In a televised interview, Douglaus was asked—not surprisingly— whether he was satisfied with a 10% inflation rate. Douglaus not only responded “no” but also added that, ideally, he’d prefer an inflation rate between 0 and 1 percent. This comment by New Zealand’s then finance minister led to that country’s central bank coming up with a price stability target that they thought would be consistent with, and supportive of, the finance minister’s comment.

In a blog titled “The History and Future of the Federal Reserve’s 2 Percent Target Rate of Inflation,” economist Roger W. Ferguson observes:

The 2 percent target widely adopted by central banks today originated from New Zealand, and surprisingly it came not from any academic study, but rather from an offhand comment during a television interview. During the late 1980s, New Zealand was going through a period of high inflation. In 1988, inflation had just come down from a high of 15 percent to around 10 percent. New Zealand’s finance minister, Roger Douglas, was pressed during a television interview about whether the government was satisfied with the now lower—albeit still high—level of inflation. Douglas replied that he was not, saying that he’d ideally want an inflation rate of between zero to 1 percent. At the time there was no set target and the remark was completely off the cuff. But now that it had been made by the nation’s finance minister, the Reserve Bank of New Zealand felt it had to work out a specific target. It determined that there tended to be an “upward bias” in inflation calculations and estimated that this bias in New Zealand was around 0.75 percent, which it rounded to 1 percent, providing a target boundary of 2 percent. Once set, it virtually became gospel among central banks. Canada and England soon adopted 2 percent as their inflation target, as did other central banks.

Once the 2% target was adopted by the Reserve Bank of New Zealand, it went —as Johns Hopkins’ economist Laurence Ball has observed— “viral”; that is, the central banks of other countries started to jump on the band wagon, adopting a 2% target rate.

The United States was a relatively late in officially adopting the 2% target. But by 2012, the Federal Reserve, under the leadership of Chair Ben Bernanke, announced that their goal would henceforth be hit the 2% target.

The point here—and it merits reiterating— is that the much hyped 2% target that we’re constantly hearing about is NOT grounded in some deep empirical research.

CONTESTING THE 2% THRESHOLD

What’s more—and you’d never know it from the typical reporting that we get on most media— a number of prominent economists have contested the Fed’s commitment to that 2% inflation target.

For instance, Johns Hopkins economist, Laurence Ball, argues that increasing the inflation target from 2% to 4% would not inflict any significant macroeconomic harm. while creating more policy space for fighting recessions (click here for Ball’s paper and a complete outlining of his argument).

Also worth noting is that a group of well-known economists penned a 2017 letter to Janet Yellen, former chair of the Fed and current Treasury Secretary, urging her and the Fed’s Board of Governors, to “reappraise” the central bank’s commitment to hitting an inflation target of 2%. The signatories to this letter included, amongst others, Joseph Stiglitz, the 2001 recipient of the Nobel Memorial Prize in the Economic Sciences, and the recently deceased William Spriggs, who served both as a long time member of Howard University’s economics department and chief economist of the AFL-CIO. According to the signatories:

Such a reassessment is particularly appropriate when the lack of evidence that moderately higher inflation would harm Americans’ standard of living is juxtaposed with the tremendous evidence that a tighter labor market would improve Americans’ standard of living

Fast foward and these words still hit. The Fed is still committed to hitting an inflation target of 2%, in spite of the fact that a) there’s no empirical evidence demonstrating that there’s something “special” about that target, b) there’s no compelling reason to believe that a moderately higher rate (say 3% or perhaps even 4%) would inflict an additional level of harm on the macroeconomy and c) there’s evidence suggesting that the Fed’s strategy may very well be contributing to a recent increase in the unemployment rate of Black and workers.

Indeed, the most recent Jobs Report indicates that while the aggregate or overall unemployment rate held steady at about 3.6% between May and June, the unemployment rate for Black workers took a big jump, rising from 5.6% to 6%.

This is the second consecutive month that the Black unemployment rate has increased: Going from April’s 4.7% to May’s 5.6% and then, of course from May’s 5.6% to June’s 6%.

The unemployment rates of Asians and Hispanics also increased between May and June, from 2.9 to 3.2 and 4.0 to 4.3, respectively. In contrast, the White unemployment rate actually declined during this period, dropping from 3.3% to 3.1%.

Black workers, though, are the only group whose unemployment rate registered consecutive increases for the last two months.

WRAPPING UP

Judged by the Consumer Price Index, inflation is now increasing at a rate of 3%, and that’s down from 9% a year ago. Even when judged by the index that the FED focuses on—Personal Consumption Expenditures or PCE— inflation is now increasing at a rate of 3.8%, down from the 4.3% annual rate measured in April 2023 (the current rate of 3.8% refers to May).

It is simply not true that inflation is still “out of control.” It’s down drastically and, furthermore, there is no evidence that a rate of 3% —or even 4%-5%— inflicts any significant harm on the economy.

What’s more, it’s definitely pass time for Jerome Powell and the Fed to cease with their rate increases—increases that are not only tethered to achieving some arbitrary goal (2% inflation rate) but may very well be exacting a toll on one of the labor market’s most economically insecure groups—Black workers.