Post by Carl LaFong on Feb 1, 2024 15:18:55 GMT
Across the world, central banks have been vowing for almost two years to return inflation to the target rate of 2%. In practice, this has meant increasing interest rates – the cost of borrowing – in order to slow down economic activity. Today, the Bank of England decided to leave interest rates in the UK at 5.25%, their highest level since 2008.
There are almost 60 countries that officially have a 2% inflation target, including the US, UK, Japan and the eurozone, but where does this actually come from? It is perhaps the most important policy objective being pursued today; you would think there must be a slew of empirical support that justifies this chosen target. After all, the target matters a great deal. If it were, say 3% or 4%, we would probably no longer be so concerned with rising prices, as many countries’ inflation has fallen to those levels.
I have spent hundreds of hours over the last few years poring over papers and documents at various central banks, going back decades, looking for some sort of document that would justify, or at least explain, the choice of a 2% target. I have not been able to find anything.
Now, I am not a fan of the 2% inflation target to begin with, as I am not convinced that inflation is “always and everywhere” a monetary phenomenon, to quote Milton Friedman – by which he meant that inflation is always about too much money in the economy. As such, I don’t think interest rates help much. I also believe that focusing on an inflation target detracts from the importance of fighting unemployment (or underemployment and low pay), which is, in my opinion, a greater problem than inflation.
But let’s focus on the choice of a 2% target. After the high inflation of the late 1970s and early 1980s, when it reached over 20% in the UK, central banks were left scrambling to find some new theoretical model to deal with rising prices. The first central bank to propose an inflation target of 2% was in New Zealand. But where did they get it from? Apparently, from thin air.
Recently, I came across this one story that suggested the choice of 2% was the result of an off the cuff remark in 1988 by the then New Zealand finance minister during a TV interview, who told reporters he would be happy with an inflation between 0% and 1%. This led the governor of the central bank at the time, Don Brash, to factor in an inflation bias of roughly 1% to arrive at the magical number of 2%. Michael Reddell, a colleague of Brash’s at the time at the Reserve Bank, admitted: “It wasn’t ruthlessly scientific.” Brash himself admitted as much: “It was almost a chance remark. The figure was plucked out of the air to influence the public’s expectations.”….
www.theguardian.com/commentisfree/2024/feb/01/the-damning-truth-about-the-uks-2-inflation-target-its-completely-made-up
There are almost 60 countries that officially have a 2% inflation target, including the US, UK, Japan and the eurozone, but where does this actually come from? It is perhaps the most important policy objective being pursued today; you would think there must be a slew of empirical support that justifies this chosen target. After all, the target matters a great deal. If it were, say 3% or 4%, we would probably no longer be so concerned with rising prices, as many countries’ inflation has fallen to those levels.
I have spent hundreds of hours over the last few years poring over papers and documents at various central banks, going back decades, looking for some sort of document that would justify, or at least explain, the choice of a 2% target. I have not been able to find anything.
Now, I am not a fan of the 2% inflation target to begin with, as I am not convinced that inflation is “always and everywhere” a monetary phenomenon, to quote Milton Friedman – by which he meant that inflation is always about too much money in the economy. As such, I don’t think interest rates help much. I also believe that focusing on an inflation target detracts from the importance of fighting unemployment (or underemployment and low pay), which is, in my opinion, a greater problem than inflation.
But let’s focus on the choice of a 2% target. After the high inflation of the late 1970s and early 1980s, when it reached over 20% in the UK, central banks were left scrambling to find some new theoretical model to deal with rising prices. The first central bank to propose an inflation target of 2% was in New Zealand. But where did they get it from? Apparently, from thin air.
Recently, I came across this one story that suggested the choice of 2% was the result of an off the cuff remark in 1988 by the then New Zealand finance minister during a TV interview, who told reporters he would be happy with an inflation between 0% and 1%. This led the governor of the central bank at the time, Don Brash, to factor in an inflation bias of roughly 1% to arrive at the magical number of 2%. Michael Reddell, a colleague of Brash’s at the time at the Reserve Bank, admitted: “It wasn’t ruthlessly scientific.” Brash himself admitted as much: “It was almost a chance remark. The figure was plucked out of the air to influence the public’s expectations.”….
www.theguardian.com/commentisfree/2024/feb/01/the-damning-truth-about-the-uks-2-inflation-target-its-completely-made-up
