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Should central banks target 2% inflation?

Inflation targeting went from being a radical view to the new orthodoxy of central banking. After most central banks have adopted it in practice, they have almost all converged on 2% as the right inflation target, although some emerging market central banks have higher inflation targets.

Yes, inflation targeting provides monetary stability

Having a positive 2% inflation target provides enough room to prevent any fall into deflation, which central banks are poorly equipped to deal with.

Low, stable inflation helps the economy operate efficiently

When inflation is low and stable, individu­als can hold money without having to worry that high inflation will rapidly erode their purchasing power.

No, even targeting 2% inflation does not lead to monetary stability

At 2% inflation, money will lose half its value in 25 years. Genuine price stability requires a target of 0% inflation.

Long-term inflation at 2% can cause an economic downturn

Lowering inflation, instead of keeping it at 2%, would be ideal in curbing the negative effects that inflation itself could have on the global economy.

Inflation is the wrong target and central banks should target nominal GDP trend growth

Targeting inflation is the wrong approach. An NGDP-targeting regime could also be more transparent and market-driven than the current interest-rate targeting regime. To further improve transparency, the Fed could engage in level targeting.

Targeting interest rates only affects demand, not supply

Both NGDP targeting and inflation targeting respond to demand shocks by adjusting the money supply to offset any change in the velocity of money (the rate at which money passes from one holder to another). However, NGDP targeting also responds appropriately to a supply shock in any sector of the economy.

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This page was last edited on Monday, 24 Feb 2020 at 12:13 UTC