The Latest Innovation in Inflation Targeting

In 2016, I wrote a piece at highly critical of inflation targeting. At that time the idea of a 2% inflation target was fast becoming mainstream. Since then it has become a routine yardstick for assessing economic policies.1 It was a hit with politicians, liberal economists, and borrowers around the world because with inflation running below that level in most major economies it was a license to keep printing money. And now, with inflation closing in on 2%, the easy money crowd has done exactly what I expected and trotted out phase II: the new target is to average 2%. In other words since we were below 2% for so long, a rise to 3% or 4% for a while is somehow desirable.
The 2%, one-size-fits-all rate, was probably chosen for the reasons above plus it was an innocuous sounding round integer, which level existed for a while during some past economic upswings. However, common sense dictates that one size doesn’t fit all. There are situations where zeroish inflation is appropriate, where healthy competition – internal and external – plus innovation and automation are rampant. On the other hand, during supply shocks, such as the oil crisis of the 1970s, higher than 2% must be tolerated to avoid disaster.
The scary thing is that inflation targeting involves deliberately inflating as a routine policy tool for managing the economy. This is a blatant departure from a central bank’s traditional duty to protect the purchasing power of a currency. In a massively indebted country, such as ours, downgrading this ‘sacred duty’ multiplies the risk of instability. Nevertheless, the idea managed to work its way into mainstream thinking without scaring as many people as it should have.

This post was published at Ludwig von Mises Institute on Oct 25, 2017.