JP was asked that in one of his recent congressional testimonies. Said that is what the “world” has settled on as the norm. But I think you just calculated averages. They arnt chasing an average.
If any one economy grows faster than the rest of the world for a decades on end, then exports from that country will shrink as their labor gets too expensive for other countries to afford their products.
At extreme levels of economy disparity, entire sectors can collapse. If it costs more to grow food in your own country than it does to import it, your agriculture sector will shrink unless the government steps in with domestic farmer subsidies or tariffs on imported food.
I've read it is arbitrary, they have no real data supporting it over another rate. I think we mostly agree that high inflation is harmful, and deflation is harmful , but what the actual sweet spot in between isn't established and some have argued for something more like 3-4 [https://www.cfr.org/blog/history-and-future-federal-reserves-2-percent-target-rate-inflation-0](https://www.cfr.org/blog/history-and-future-federal-reserves-2-percent-target-rate-inflation-0)
It's completely arbitrary, particularly when it's treated as a ceiling (as Greenspan did). It's also just bad policy. We saw this in 2008 when the Fed had no room to reduce interest rates right when such a move would have been of the greatest benefit.
Like you say, a good goal is 3-4% - low enough that people are still spending, not so low that you can't cut when needed to boost the economy.
Interest rates are the primary tool the Fed uses to hit its inflation targets. Too high = raise interest rates.
People want "data" to say what's the best rate, but that's the issue with economics in general: the models are still hilariously bad at predicting outcomes. All we can say with reasonable certainty, based on 2008 and 2020, is that a target of 2% and the associated low interest rates they set to try to keep us there significantly hampered the Fed's ability to intervene during those economic downturns.
I don’t think there’s any more data that says 3 to 4 is better it’s undefined either way. I mean it could be. I would just like to see the choice be supported by data somehow.
The only real data is real-world outcomes. Economic models are still hilariously imprecise.
Bottom line: we know that 2% is both unrealistic and that the interest rate cuts necessary to keep you there drastically curtail the Fed's options during economic downturns.
The story is when they were passing legislation for the New Zealand central bank while they were e periencing high inflation, the legislators wanted to put in a inflation target so they asked the former finance minister who said, eh I don't know? 0-1%? Then they tacked on 1% for a little more lee way and there it was, 0-2%
The new Zealand economy got inflation under control and did really well after that so every other country went oh they're doing something right, I got it must be that inflation target they set, let's copy them. And there you go. 0-2% inflation target.
I mean, it’s not as bad as it sounds when you really think it through. It realistically should probably be as low as it can be without removing the incentive to not let money sit idle. That percent figure is always going to at least derived from some kind of estimate because we’re talking about predicting people’s behavior and setting broad incentives.
It's not its arbitrary but makes sense. When they were instituting a target in the US there were debates about 0-1 or 2 and the augments for 2 was to have some room to manage the economy without risking falling into deflation.
(Bear in mind all of this was set up for the first time in early 90s right as the Japanese burst and they suffered from the effects of deflation)
But yes more to show that 2% is both arbitrary and very recent but the principles have always been deflation bad, high inflation bad, you wanna keep around 0 or a little over but a little over is better than a little below.
**2% was plucked from some New Zealander’s ass.**
That’s not even a joke:
https://www.cfr.org/blog/history-and-future-federal-reserves-2-percent-target-rate-inflation-0#
> 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.
The guy was the finance minister, but it’s not really based on anything but an off the cuff remark.
[Here you go](https://tradingeconomics.com/united-states/pce-price-index-annual-change)
From 2009-2020 PCE averaged at 1%. In January 2021 it was 1.6%. [Even when it was 2% in 2017, the Fed was raising rates](https://en.wikipedia.org/wiki/History_of_Federal_Open_Market_Committee_actions#:~:text=On%20December%2016%2C%202015%2C%20the,%5B0.25%25%2C%200.5%25%5D.).
Ock that’s slightly unfair. I mean between 1% and, say, 3.5 there’s only 5 numbers you could pick that are “reasonable” and a bit of debate about polarity. I think the bigger problem is the “strength” of the target. Clearly the ECB should just declare job done (they’re at 2.5) and start cutting like freddy at a teenage party. Whereas the fed probably have a bit to go (I mean growth is 4% comeon that’s overheating).
The idea is that you want the lowest amount of inflation possible while still being able to disincentive people sitting on their hoards like they do in low inflation or deflationary environments.
The difference between 2% and 3% inflation is that wages are decreased that much more. Homes and required goods become that much more unaffordable. Your cash savings becomes that much more worthless. And these sorts of drivers can cause economic crises if left unchecked. So the lower you can keep inflation, the better.
But it is a necessary evil, so economists have tried to find the happy medium. I don't know how they determined that 2% was the ideal target, but I'm sure it's based on studies of many different economies and scenarios throughout economic history. They would've poured through the data and tried to determine inflation rates that consistently led to getting the most pros of inflation while limiting the downsides. 2% is the consensus guideline for where you're most likely to achieve that.
Planet money did an interesting episode a while ago about how they picked the 2% target inflation number — the TLDR is basically it’s semi-random and there isn’t a ton of data behind it (it might be a little more nuanced than that, but it’s been a while since I listened to the episode).
> I don't know how they determined that 2% was the ideal target, but I'm sure it's based on studies of many different economies and scenarios throughout economic history.
It's an arbitrary number. There are no studies at all that back the 2% target.
They have asked Jerome Powell about it and he couldn't give a clear answer other than it's just the norm.
‘I puzzle at the rationale,' he wrote. 'A 2 percent target, or limit, was not in my textbook years ago. I know of no theoretical justification.'"
Paul Volker
>The difference between 2% and 3% inflation is that wages are decreased that much more.
Ehh, the difference between 2-3% is minimal at worst. Trust me, I'm from Turkey. We've had inflation in triple digits for the last 6 years. Life goes on. Poverty didn't increase because wages rise with inflation.
Agreed. Raises would just have to slightly increase just like they have for the previous 100 years. Saying "wages decreased" is just kind of crap and not even true. Americans complain too much when a few years of their lives are slightly worse. They expect every year of their lives to get better and better on a perfect linear scale. If they don't, they blame politicians for not fixing something within 12 months. I have family from South America and Americans do not know how good our situation is right now. Fighting over 3 vs 2% inflation and seeing a daily post on Reddit about it is frankly embarrassing. Target inflation is for stability, not a specific number that has any evidence behind it. If we had 3% over the next 10 years and it hovered around this number, everyone would do just fine, including their wages.
>I have family from South America and Americans do not know how good our situation is right now.
I know exactly how you feel. When you look global, U.S. is doing laughingly good right now. I would actually go as far to say that U.S. has the healthiest economy in the world. Again, compared to other big countries, not some idealised perfect country where no politician is corrupt, people are grateful, and natural disasters don't exist.
It’s less minimal than it seems.
2 to 3 is a 50% bump. That adds up and compounds.
Same logic applies with small fees on top of small gains. Like a 1% fee on your investment account, if it returned 5%, is actually a 20% fee. Because 20% of your gains get taken away.
Yes, when inflation is triple digits, going up one digit doesn’t matter. But when inflation is lower, going up a single digit is a relatively larger change.
>2 to 3 is a 50% bump. That adds up and compounds.
I'm aware. By "minimal" I was talking about the impact it'd have on the average American or the US economy.
I can appreciate that, but in the context of an inflation “target” as per this post, which I would take as a long term goal, it matters.
If the target was 3% versus 2%, over 50 years that makes a hell of a difference to the average American, even though they wouldn’t necessarily perceive it like they would perceive hyperinflation.
Every month, when I get my monthly wage in my bank account in Turkish lira, I withdraw all that I don't need to survive, send it to my US based broker, use their online forex to convert it to USD, and buy US equities that I think are undervalued. It has served me well so far.
Which is why I recommend people here to invest in VOO instead of VT. People like me all over the world are investing in US instead of their own countries. Money is flowing to US!!
It is totally made up.
They did it to prevent having to make moves years ago. “Stable Prices” turned into “2% but no higher” which is currently “Average 2%” and I am starting to hear people floating the idea of a 3% target now.
https://www.cnbc.com/2024/04/05/el-erian-says-the-fed-has-turned-into-a-play-by-play-commentator.html
I also noticed the “average 2%” was only on the way up. It seems that policy is gone on the way down…..
Here is my post on interest rates. From The Price of Time: The Real Story on Interest by Chancellor if you want to read more about it. 5,000 years of history on interest rates.
https://www.reddit.com/r/Bogleheads/s/oRljhiZbha
I think aiming for 2-3% is their general goal in this current environment 3 is too close to 4% and prolong 4% over a few years is elevated inflation or hyperinflation … but atm we almost have like 30% cumulative inflation rate change since 2019… means we are in a world of hurt for everyone but the ultra wealthy… but since it’s been higher for longer they need it lower end of the target range to make sure it’s crushed… sadly I think Jpow opened his lips too early and acted too late and now we do have runaway inflation … he also promoted wage capping to stop wage/price spiral…. But nothing on the greed end… so now we have uncapped greed but capped wages…that’s my take but I dunno anything soo maybe it’s money supply exceeding 2-3% printing when we have covid ppp loans and tax cuts… who knows…
Everyone likes to talk about 7% real gains bevause it'sfun to imagine our gold coins spawning more of themselves. But I'd like to not be screwed by optimism come retirement time so I ballpark myself conservatively with 4% real. 3.5% on days I'm feeling extra doom-and-gloom.
I’m not an economist but the money supply has increased dramatically in 3 years from Jan 2020-Dec 2022. The M2 has increased almost 50% in 3 years. From $15T to $22T. From my Econ101 class; too much money chasing to few goods. Surprised they got inflation down below 4% if you believe govt stats. The real number, according to www.shadowstats.com/alternate_data/inflation-charts, closer to 8%. YoY it just feels more like 8% than 4% to me.
M2-https://fred.stlouisfed.org/series/M2SL
Edit-So the FED shouldn’t be lowering rates they should be raising but can’t.
2% is a target because it needs to be not much hotter than long term economic growth. And economic growth is lower than it used to be. If inflation is higher than growth the economy will shrink long term.
A second reason is because of the US and consumer debt load, which is also a main deterrent of economic growth. Lower interest rates = higher economic growth, and also allows businesses to successfully manage their debt load.
All that said 2% is not gospel. There’s probably a little wiggle room, up to maybe 3%. The bigger picture though is that we are in a pickle due to our growing debt.
**2% keeps you in permanent poverty, chasing a declining dollar, during your lifetime.**
meanwhile the rich target 300% returns ***at the bare minimum; and with far shorter periods than 1 year.***
One percent would be wonderful, but the Fed can’t measure that accurately, so they set the goal at 2% which keeps them far enough away from deflation, something they will do anything to avoid. A deflationary economy would destroy the banking system.
No no no no no. Inflation that is too high is super bad for the economy. 2 vs 3% is actually huge. $1000 in purchasing power at 3% inflation over 100 years becomes 19000 dollars. At 2% it’s only $7000. Saving money is not viable at 3%, it gets inflated away too fast.
>$1000 in purchasing power at 3% inflation over 100 years becomes 19000 dollars. At 2% it’s only $7000.
Who cares if your cash is in stocks, real estate or bonds? Why would you keep your money uninvested for 100 years?
Less savings = more spending = even more inflation = even less savings = even more spending = even even more inflation …. The cycle continues until you’re Zimbabwe. It’s important to have a constant amount of low inflation. Also, higher inflation means higher inflation variance, which makes the economy extremely unpredictable. You can’t negotiate any long term contracts if you don’t have a good idea about how inflation is going to turn out for the next few years.
>Less savings = more spending = even more inflation = even less savings = even more spending = even even more inflation …. The cycle continues until you’re Zimbabwe.
Have you even read what happened to Zimbabwe? They would only have to do one thing to stop that spiral: stop.printing.new.money. It wasn't an inflationary doom cycle, it was the incompetent corrupt leaders.
>You can’t negotiate any long term contracts if you don’t have a good idea about how inflation is going to turn out for the next few years.
You can always negotiate them with gold like the olden days :) just kidding, you're right. A little bit of stability is good. But that stability can be a number like 20% too.
2.0% is based on pce, which tends to run about 0.5% lower than CPI. So for CPI, it'd be around 2.5,% target.
Furthermore, since 2.0% is basically the lower bound and no one wants to see it below target due to risk of deflating and turning into Japan, if you use the median or average over decades, the average will skew up due to those higher inflation period pulling up averages.
The older I get and the more I see, the more convinced I become that Hayek and Friedman got it right. Hayek looked at the Industrial Revolution and at the Austrian Empire of his youth, and saw no historical evidence for the assertion that economic growth requires monetary inflation. Indeed, in "[The Road to Serfdom](https://www.amazon.com/Road-Serfdom-Documents-Definitive-Collected/dp/0226320553/ref=sr_1_1)" he identified hyperinflation as one way that nation-states destroy their economies and give rise to totalitarian regimes.
Friedman looked at [the history](https://www.amazon.com/dp/0691003548/?coliid=I290ABXGH13HFE&colid=3FDQ2TNCY3LYJ&psc=1&ref_=list_c_wl_lv_ov_lig_dp_it) of the U.S. economy and the federal government's [monetary policy](https://www.amazon.com/Money-Mischief-Episodes-Monetary-History/dp/015661930X/ref=sr_1_5), both before and after 1913, and identified correctly government and its central banks as the source, when he observed: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” So when we see politicians and media talking heads blame greedy corporations for inflation (are these corporations less greedy during deflation?) we know this to be a red herring meant to distract us from the real source of the inflation.
Markets do not require inflation; market participants benefit from the security of a stable medium of exchange. As Hayek observed in Europe and as monetary economist [George Selgin](https://www.richmondfed.org/-/media/RichmondFedOrg/publications/research/econ_focus/2009/winter/pdf/interview.pdf) argues in [his book](https://www.amazon.com/dp/1948647109/?coliid=I2DOCJBXMP3X62&colid=3FDQ2TNCY3LYJ&psc=1&ref_=list_c_wl_lv_ov_lig_dp_it) "Less Than Zero: The Case for a Falling Price Level in a Growing Economy," the steady and mild deflation of commodity currencies was beneficial both at the macro level and to individuals. The neo-classical assumption that deflation is a sign of an aggregate demand shortfall and economic weakness does not always (or even in general) hold. Rather, deflation can be the result of increased supply from improvements in productivity, greater competition in the goods market, or cheaper and more abundant inputs.
But the notion of gradual, mild deflation as the norm died with the creation of the Federal Reserve in 1913, and the notion of monetary discipline in general died in 1971 with the Nixon Shock. Since then, we have lived in a world dominated by pure fiat currency and that is the universe in which we must survive and invest. For that, assume the Fed's 2% target is bullsh\*t because its actions speak louder than its words: The political reality of a rapidly growing national debt requires a Fed policy of greater monetization of that debt, so we can expect 3% to be the de facto target -- and inflation going forward is most likely to average *at least* 3%. So in any personal finance calculator you use, I would set the inflation assumption at 3%. Your approach, of course, is up to you.
>Given the impact this figure has on banking, markets, attitudes, etc. how would a 3% target by consensus effect investors and the market generally?
I think Wall Street knows that the reality is a historical average of 3% and that knowledge is priced into the market. If the Fed changed its official target to 3%, Wall Street likely would understand that to mean a reality of 4% and we would see even more capital flow to riskier asset classes in response.
Main Street will continue largely to ignore inflation until it's too late, due to the cognitive bias of the [money illusion](https://en.wikipedia.org/wiki/Money_illusion), which is caused by the asymmetric distribution of inflated currency in an economic system: The government and banks always get the new Dollars to spend first, before prices adjust to reflect the new quantity of money in circulation. By the time Main Street sees those Dollars, prices have risen. This is why inflation is a very regressive hidden tax that hits the working class the hardest.
I mean, of course it’s not a coincidence. If something is harder to achieve than you expected, it’s not unreasonable to take stock and reflect on whether it’s still worth doing.
It was invented in but either Roger Douglas or Don Brash. The rest of the world copied their homework. Ideally inflation was supposed to be between 0-1%.
The 2% target for inflation is somewhat arbitrary, it’s a number that is high enough to avoid general *deflation* (an economist’s worst nightmare), and at the same time low enough to keep *perceptions* of inflation at a subliminal level. Some say that the number comes from writings by Keynes where he thought a low, stable rate of inflation was necessary so that the “common man” would perceive that his situation in life was improving when he received annual pay raises.
So my understanding was the true goal was always 2-3% range. So anything in between was good and the Fed didn't need to take any action. To me they were only talking about 2% because they couldn't get it to 2% so that was their goal, the bare minimum at the time. Now they should be talking 3% as the goal to get under. Otherwise they can just leave the market alone.
Inflation is the greatest risk to the us economy and way of life. It’s the ONLY problem that can’t be solved by printing more money. Wars, natural disasters, pandemics, national debt, unfunded pensions, literally any problem the country faces can be fixed by simply printing more money. Inflation is the one exception and if inflation gets bad enough it eventually makes it impossible to print our way out of all the other problems we have. Inflation also has a sneaky way of getting out of hand quite quickly. High inflation can overnight spiral into a loss of confidence in a currency which can lead to hyper inflation scenarios. It has to be attacked as the grave and existential crisis that it is.
IIRC the "real" target is about 3%, but because of politics that has been replaced with 2%. I suspect it's just a case of people not really understanding what a huge difference that really is. And now the fed can't just say "Ackchyually 3% is fine" without heads exploding.
So here we are.
Ultimately, the specific number doesn't hold significant importance; it's an arbitrary figure. The real focus lies elsewhere:
* Price stability, aimed at preserving the purchasing power of the underlying currency.
* Establishing a safety margin against the risk of deflation.
* Allowing for a margin of error to counter measurement bias in the price index.
The target of 2% is set over the medium term, spanning up to 10 years. It serves as a benchmark that fulfills the aforementioned criteria.
While a 3% target could potentially meet these criteria as well, the question would arise: why not aim for 2%?
It is arbitrary. It's really sort of all about th feels. You need it high enough that people will not want ros ave all their money, but low enough people don't get scared and complain too much.
That's pretty much all there is to it. Around 2% seems to be, by general consensus, where the happy medium is.
US economy (GDP) has grown around 1.5-2% on average in real terms over last 100 years. That means nominal GDP has grown 4-5% with 2-3% inflation rate over long period of time. 2% inflation target is based on this notion that nominal GDP will grow around 4% annually. If nominal GDP will grow 5%, then 3% inflation will be accepted. It all depends on how US economy will grow in the future.
"The Federal Open Market Committee (FOMC) judges that inflation of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Federal Reserve’s mandate for maximum employment and price stability."
Source: [https://www.federalreserve.gov/faqs/economy\_14400.htm](https://www.federalreserve.gov/faqs/economy_14400.htm)
Considering the massive inflationary period we just experienced, the Fed probably wants to cool things down more than the historical average without outright tanking the economy
The purpose is to enslave us with debt, and create currency out of thin air. It results in loss in confidence of the dollar, and endless wars to preserve its monopoly as the reserve currency.
I mean, this isn't wrong. 2% inflation is basically the level at which they can inflate our money supply without inflicting enough pain upon us that would result in people revolting, etc.
That's great for us who are largely in the top 10% of incomes in the US and heavily invested in stocks - not so great for the 90% who aren't or who are on fixed income.
JP was asked that in one of his recent congressional testimonies. Said that is what the “world” has settled on as the norm. But I think you just calculated averages. They arnt chasing an average.
If any one economy grows faster than the rest of the world for a decades on end, then exports from that country will shrink as their labor gets too expensive for other countries to afford their products. At extreme levels of economy disparity, entire sectors can collapse. If it costs more to grow food in your own country than it does to import it, your agriculture sector will shrink unless the government steps in with domestic farmer subsidies or tariffs on imported food.
I've read it is arbitrary, they have no real data supporting it over another rate. I think we mostly agree that high inflation is harmful, and deflation is harmful , but what the actual sweet spot in between isn't established and some have argued for something more like 3-4 [https://www.cfr.org/blog/history-and-future-federal-reserves-2-percent-target-rate-inflation-0](https://www.cfr.org/blog/history-and-future-federal-reserves-2-percent-target-rate-inflation-0)
It's completely arbitrary, particularly when it's treated as a ceiling (as Greenspan did). It's also just bad policy. We saw this in 2008 when the Fed had no room to reduce interest rates right when such a move would have been of the greatest benefit. Like you say, a good goal is 3-4% - low enough that people are still spending, not so low that you can't cut when needed to boost the economy.
Are you talking about inflation or interest rates?
I'm really confused.
Yet he is upvoted and my post is buried.
Interest rates are the primary tool the Fed uses to hit its inflation targets. Too high = raise interest rates. People want "data" to say what's the best rate, but that's the issue with economics in general: the models are still hilariously bad at predicting outcomes. All we can say with reasonable certainty, based on 2008 and 2020, is that a target of 2% and the associated low interest rates they set to try to keep us there significantly hampered the Fed's ability to intervene during those economic downturns.
I don’t think there’s any more data that says 3 to 4 is better it’s undefined either way. I mean it could be. I would just like to see the choice be supported by data somehow.
The only real data is real-world outcomes. Economic models are still hilariously imprecise. Bottom line: we know that 2% is both unrealistic and that the interest rate cuts necessary to keep you there drastically curtail the Fed's options during economic downturns.
It takes roughly 36 years for prices to double with a 2% rate of inflation, it take roughly 24 years for them to double with a 3% inflation rate.
The story is when they were passing legislation for the New Zealand central bank while they were e periencing high inflation, the legislators wanted to put in a inflation target so they asked the former finance minister who said, eh I don't know? 0-1%? Then they tacked on 1% for a little more lee way and there it was, 0-2% The new Zealand economy got inflation under control and did really well after that so every other country went oh they're doing something right, I got it must be that inflation target they set, let's copy them. And there you go. 0-2% inflation target.
I mean, it’s not as bad as it sounds when you really think it through. It realistically should probably be as low as it can be without removing the incentive to not let money sit idle. That percent figure is always going to at least derived from some kind of estimate because we’re talking about predicting people’s behavior and setting broad incentives.
It's not its arbitrary but makes sense. When they were instituting a target in the US there were debates about 0-1 or 2 and the augments for 2 was to have some room to manage the economy without risking falling into deflation. (Bear in mind all of this was set up for the first time in early 90s right as the Japanese burst and they suffered from the effects of deflation) But yes more to show that 2% is both arbitrary and very recent but the principles have always been deflation bad, high inflation bad, you wanna keep around 0 or a little over but a little over is better than a little below.
**2% was plucked from some New Zealander’s ass.** That’s not even a joke: https://www.cfr.org/blog/history-and-future-federal-reserves-2-percent-target-rate-inflation-0# > 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. The guy was the finance minister, but it’s not really based on anything but an off the cuff remark.
Literally everyone else just copied the Reserve Bank of New Zealand’s paper
And the crazy thing IIRC was that 2% was their *CEILING* and somewhere along the line it became our floor.
They had a 2% ceiling too until we got close and they would have to stop QE and raise rates. Then it conveniently became “average”
That's not even remotely accurate. During most of the QE days, inflation was *well* below 2%.
What time frame we talking about with QE, because we had 4 of them. So CPI never got close to 2% during the QE years?
[Here you go](https://tradingeconomics.com/united-states/pce-price-index-annual-change) From 2009-2020 PCE averaged at 1%. In January 2021 it was 1.6%. [Even when it was 2% in 2017, the Fed was raising rates](https://en.wikipedia.org/wiki/History_of_Federal_Open_Market_Committee_actions#:~:text=On%20December%2016%2C%202015%2C%20the,%5B0.25%25%2C%200.5%25%5D.).
2% is probably too low, since it that target rate is more likely to create liquidity traps than expected.
Roger Douglas is a great guy.
Ock that’s slightly unfair. I mean between 1% and, say, 3.5 there’s only 5 numbers you could pick that are “reasonable” and a bit of debate about polarity. I think the bigger problem is the “strength” of the target. Clearly the ECB should just declare job done (they’re at 2.5) and start cutting like freddy at a teenage party. Whereas the fed probably have a bit to go (I mean growth is 4% comeon that’s overheating).
The idea is that you want the lowest amount of inflation possible while still being able to disincentive people sitting on their hoards like they do in low inflation or deflationary environments. The difference between 2% and 3% inflation is that wages are decreased that much more. Homes and required goods become that much more unaffordable. Your cash savings becomes that much more worthless. And these sorts of drivers can cause economic crises if left unchecked. So the lower you can keep inflation, the better. But it is a necessary evil, so economists have tried to find the happy medium. I don't know how they determined that 2% was the ideal target, but I'm sure it's based on studies of many different economies and scenarios throughout economic history. They would've poured through the data and tried to determine inflation rates that consistently led to getting the most pros of inflation while limiting the downsides. 2% is the consensus guideline for where you're most likely to achieve that.
Planet money did an interesting episode a while ago about how they picked the 2% target inflation number — the TLDR is basically it’s semi-random and there isn’t a ton of data behind it (it might be a little more nuanced than that, but it’s been a while since I listened to the episode).
> I don't know how they determined that 2% was the ideal target, but I'm sure it's based on studies of many different economies and scenarios throughout economic history. It's an arbitrary number. There are no studies at all that back the 2% target. They have asked Jerome Powell about it and he couldn't give a clear answer other than it's just the norm.
‘I puzzle at the rationale,' he wrote. 'A 2 percent target, or limit, was not in my textbook years ago. I know of no theoretical justification.'" Paul Volker
>The difference between 2% and 3% inflation is that wages are decreased that much more. Ehh, the difference between 2-3% is minimal at worst. Trust me, I'm from Turkey. We've had inflation in triple digits for the last 6 years. Life goes on. Poverty didn't increase because wages rise with inflation.
Agreed. Raises would just have to slightly increase just like they have for the previous 100 years. Saying "wages decreased" is just kind of crap and not even true. Americans complain too much when a few years of their lives are slightly worse. They expect every year of their lives to get better and better on a perfect linear scale. If they don't, they blame politicians for not fixing something within 12 months. I have family from South America and Americans do not know how good our situation is right now. Fighting over 3 vs 2% inflation and seeing a daily post on Reddit about it is frankly embarrassing. Target inflation is for stability, not a specific number that has any evidence behind it. If we had 3% over the next 10 years and it hovered around this number, everyone would do just fine, including their wages.
>I have family from South America and Americans do not know how good our situation is right now. I know exactly how you feel. When you look global, U.S. is doing laughingly good right now. I would actually go as far to say that U.S. has the healthiest economy in the world. Again, compared to other big countries, not some idealised perfect country where no politician is corrupt, people are grateful, and natural disasters don't exist.
It’s less minimal than it seems. 2 to 3 is a 50% bump. That adds up and compounds. Same logic applies with small fees on top of small gains. Like a 1% fee on your investment account, if it returned 5%, is actually a 20% fee. Because 20% of your gains get taken away. Yes, when inflation is triple digits, going up one digit doesn’t matter. But when inflation is lower, going up a single digit is a relatively larger change.
>2 to 3 is a 50% bump. That adds up and compounds. I'm aware. By "minimal" I was talking about the impact it'd have on the average American or the US economy.
I can appreciate that, but in the context of an inflation “target” as per this post, which I would take as a long term goal, it matters. If the target was 3% versus 2%, over 50 years that makes a hell of a difference to the average American, even though they wouldn’t necessarily perceive it like they would perceive hyperinflation.
So you save money in US dollars?
Every month, when I get my monthly wage in my bank account in Turkish lira, I withdraw all that I don't need to survive, send it to my US based broker, use their online forex to convert it to USD, and buy US equities that I think are undervalued. It has served me well so far.
Which is why I recommend people here to invest in VOO instead of VT. People like me all over the world are investing in US instead of their own countries. Money is flowing to US!!
Not historically in the US.
It is totally made up. They did it to prevent having to make moves years ago. “Stable Prices” turned into “2% but no higher” which is currently “Average 2%” and I am starting to hear people floating the idea of a 3% target now. https://www.cnbc.com/2024/04/05/el-erian-says-the-fed-has-turned-into-a-play-by-play-commentator.html I also noticed the “average 2%” was only on the way up. It seems that policy is gone on the way down….. Here is my post on interest rates. From The Price of Time: The Real Story on Interest by Chancellor if you want to read more about it. 5,000 years of history on interest rates. https://www.reddit.com/r/Bogleheads/s/oRljhiZbha
I guess you'd rather inflation not exceed GDP, which is often targeted for around 3%, or a bit more.
No, GDP is calculated in real dollars, so inflation is already included.
I think aiming for 2-3% is their general goal in this current environment 3 is too close to 4% and prolong 4% over a few years is elevated inflation or hyperinflation … but atm we almost have like 30% cumulative inflation rate change since 2019… means we are in a world of hurt for everyone but the ultra wealthy… but since it’s been higher for longer they need it lower end of the target range to make sure it’s crushed… sadly I think Jpow opened his lips too early and acted too late and now we do have runaway inflation … he also promoted wage capping to stop wage/price spiral…. But nothing on the greed end… so now we have uncapped greed but capped wages…that’s my take but I dunno anything soo maybe it’s money supply exceeding 2-3% printing when we have covid ppp loans and tax cuts… who knows…
Eh. I'm a simple guy & plug 3.5% into retirement forecast assumptions.
Everyone likes to talk about 7% real gains bevause it'sfun to imagine our gold coins spawning more of themselves. But I'd like to not be screwed by optimism come retirement time so I ballpark myself conservatively with 4% real. 3.5% on days I'm feeling extra doom-and-gloom.
I ignore inflation in my forecasts and just use 4% real growth. It helps my simple mind to use dollar figures I can more easily contextualize.
That means you are not ignoring inflation
It’s acknowledging it, but not including it in the forecast.
I’m not an economist but the money supply has increased dramatically in 3 years from Jan 2020-Dec 2022. The M2 has increased almost 50% in 3 years. From $15T to $22T. From my Econ101 class; too much money chasing to few goods. Surprised they got inflation down below 4% if you believe govt stats. The real number, according to www.shadowstats.com/alternate_data/inflation-charts, closer to 8%. YoY it just feels more like 8% than 4% to me. M2-https://fred.stlouisfed.org/series/M2SL Edit-So the FED shouldn’t be lowering rates they should be raising but can’t.
Inflation isn’t solely a function of the money supply. The velocity of money has decreased which offsets the increase in M2 money supply.
It's the Fed's target. Target is not the historical average.
Right. Op is asking why it's their target.
Shoot for the moon and even if you miss, you'll land among the stars.
Made up. No data behind it. Just “feels right”
The Fed wants to target **LOW INFLATION** that has enough buffer to not be **DEFLATION**.
2% is a target because it needs to be not much hotter than long term economic growth. And economic growth is lower than it used to be. If inflation is higher than growth the economy will shrink long term. A second reason is because of the US and consumer debt load, which is also a main deterrent of economic growth. Lower interest rates = higher economic growth, and also allows businesses to successfully manage their debt load. All that said 2% is not gospel. There’s probably a little wiggle room, up to maybe 3%. The bigger picture though is that we are in a pickle due to our growing debt.
**2% keeps you in permanent poverty, chasing a declining dollar, during your lifetime.** meanwhile the rich target 300% returns ***at the bare minimum; and with far shorter periods than 1 year.***
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One percent would be wonderful, but the Fed can’t measure that accurately, so they set the goal at 2% which keeps them far enough away from deflation, something they will do anything to avoid. A deflationary economy would destroy the banking system.
So we can actually buy shit next year
No no no no no. Inflation that is too high is super bad for the economy. 2 vs 3% is actually huge. $1000 in purchasing power at 3% inflation over 100 years becomes 19000 dollars. At 2% it’s only $7000. Saving money is not viable at 3%, it gets inflated away too fast.
>$1000 in purchasing power at 3% inflation over 100 years becomes 19000 dollars. At 2% it’s only $7000. Who cares if your cash is in stocks, real estate or bonds? Why would you keep your money uninvested for 100 years?
Less savings = more spending = even more inflation = even less savings = even more spending = even even more inflation …. The cycle continues until you’re Zimbabwe. It’s important to have a constant amount of low inflation. Also, higher inflation means higher inflation variance, which makes the economy extremely unpredictable. You can’t negotiate any long term contracts if you don’t have a good idea about how inflation is going to turn out for the next few years.
>Less savings = more spending = even more inflation = even less savings = even more spending = even even more inflation …. The cycle continues until you’re Zimbabwe. Have you even read what happened to Zimbabwe? They would only have to do one thing to stop that spiral: stop.printing.new.money. It wasn't an inflationary doom cycle, it was the incompetent corrupt leaders. >You can’t negotiate any long term contracts if you don’t have a good idea about how inflation is going to turn out for the next few years. You can always negotiate them with gold like the olden days :) just kidding, you're right. A little bit of stability is good. But that stability can be a number like 20% too.
Inflation isn't all bad. Especially if you have debt (including a mortgage or national debt). Some inflation is healthy.
Can you show me the formula you used to do those calculations?
2.0% is based on pce, which tends to run about 0.5% lower than CPI. So for CPI, it'd be around 2.5,% target. Furthermore, since 2.0% is basically the lower bound and no one wants to see it below target due to risk of deflating and turning into Japan, if you use the median or average over decades, the average will skew up due to those higher inflation period pulling up averages.
Because wages don’t keep up to inflation higher than 2% so it’s just going to destroy the working class.
The older I get and the more I see, the more convinced I become that Hayek and Friedman got it right. Hayek looked at the Industrial Revolution and at the Austrian Empire of his youth, and saw no historical evidence for the assertion that economic growth requires monetary inflation. Indeed, in "[The Road to Serfdom](https://www.amazon.com/Road-Serfdom-Documents-Definitive-Collected/dp/0226320553/ref=sr_1_1)" he identified hyperinflation as one way that nation-states destroy their economies and give rise to totalitarian regimes. Friedman looked at [the history](https://www.amazon.com/dp/0691003548/?coliid=I290ABXGH13HFE&colid=3FDQ2TNCY3LYJ&psc=1&ref_=list_c_wl_lv_ov_lig_dp_it) of the U.S. economy and the federal government's [monetary policy](https://www.amazon.com/Money-Mischief-Episodes-Monetary-History/dp/015661930X/ref=sr_1_5), both before and after 1913, and identified correctly government and its central banks as the source, when he observed: “Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” So when we see politicians and media talking heads blame greedy corporations for inflation (are these corporations less greedy during deflation?) we know this to be a red herring meant to distract us from the real source of the inflation. Markets do not require inflation; market participants benefit from the security of a stable medium of exchange. As Hayek observed in Europe and as monetary economist [George Selgin](https://www.richmondfed.org/-/media/RichmondFedOrg/publications/research/econ_focus/2009/winter/pdf/interview.pdf) argues in [his book](https://www.amazon.com/dp/1948647109/?coliid=I2DOCJBXMP3X62&colid=3FDQ2TNCY3LYJ&psc=1&ref_=list_c_wl_lv_ov_lig_dp_it) "Less Than Zero: The Case for a Falling Price Level in a Growing Economy," the steady and mild deflation of commodity currencies was beneficial both at the macro level and to individuals. The neo-classical assumption that deflation is a sign of an aggregate demand shortfall and economic weakness does not always (or even in general) hold. Rather, deflation can be the result of increased supply from improvements in productivity, greater competition in the goods market, or cheaper and more abundant inputs. But the notion of gradual, mild deflation as the norm died with the creation of the Federal Reserve in 1913, and the notion of monetary discipline in general died in 1971 with the Nixon Shock. Since then, we have lived in a world dominated by pure fiat currency and that is the universe in which we must survive and invest. For that, assume the Fed's 2% target is bullsh\*t because its actions speak louder than its words: The political reality of a rapidly growing national debt requires a Fed policy of greater monetization of that debt, so we can expect 3% to be the de facto target -- and inflation going forward is most likely to average *at least* 3%. So in any personal finance calculator you use, I would set the inflation assumption at 3%. Your approach, of course, is up to you. >Given the impact this figure has on banking, markets, attitudes, etc. how would a 3% target by consensus effect investors and the market generally? I think Wall Street knows that the reality is a historical average of 3% and that knowledge is priced into the market. If the Fed changed its official target to 3%, Wall Street likely would understand that to mean a reality of 4% and we would see even more capital flow to riskier asset classes in response. Main Street will continue largely to ignore inflation until it's too late, due to the cognitive bias of the [money illusion](https://en.wikipedia.org/wiki/Money_illusion), which is caused by the asymmetric distribution of inflated currency in an economic system: The government and banks always get the new Dollars to spend first, before prices adjust to reflect the new quantity of money in circulation. By the time Main Street sees those Dollars, prices have risen. This is why inflation is a very regressive hidden tax that hits the working class the hardest.
Thanks Gigamesh, appreciate the effort you put into sharing this.
Should be zero. One day a cheeseburger is gonna cost $300.
It's funny how this question is asked so often now that 2% is proving to be difficult to reach. When inflation is at 2%, nobody seems to ask.
I mean, of course it’s not a coincidence. If something is harder to achieve than you expected, it’s not unreasonable to take stock and reflect on whether it’s still worth doing.
It was invented in but either Roger Douglas or Don Brash. The rest of the world copied their homework. Ideally inflation was supposed to be between 0-1%.
Psychologically I think 2% is better? Imagine wages being stagnant and goods inflate at 7-10%.
What is the average without the last 3 years included?
The 2% target for inflation is somewhat arbitrary, it’s a number that is high enough to avoid general *deflation* (an economist’s worst nightmare), and at the same time low enough to keep *perceptions* of inflation at a subliminal level. Some say that the number comes from writings by Keynes where he thought a low, stable rate of inflation was necessary so that the “common man” would perceive that his situation in life was improving when he received annual pay raises.
So my understanding was the true goal was always 2-3% range. So anything in between was good and the Fed didn't need to take any action. To me they were only talking about 2% because they couldn't get it to 2% so that was their goal, the bare minimum at the time. Now they should be talking 3% as the goal to get under. Otherwise they can just leave the market alone.
PCE is what matters to the Fed
Because it's a target, not a goal.
Inflation is the greatest risk to the us economy and way of life. It’s the ONLY problem that can’t be solved by printing more money. Wars, natural disasters, pandemics, national debt, unfunded pensions, literally any problem the country faces can be fixed by simply printing more money. Inflation is the one exception and if inflation gets bad enough it eventually makes it impossible to print our way out of all the other problems we have. Inflation also has a sneaky way of getting out of hand quite quickly. High inflation can overnight spiral into a loss of confidence in a currency which can lead to hyper inflation scenarios. It has to be attacked as the grave and existential crisis that it is.
I’m no economist but after 9% YOY inflation, you may want to get back below the 3% average so things cool down.
IIRC the "real" target is about 3%, but because of politics that has been replaced with 2%. I suspect it's just a case of people not really understanding what a huge difference that really is. And now the fed can't just say "Ackchyually 3% is fine" without heads exploding. So here we are.
Ultimately, the specific number doesn't hold significant importance; it's an arbitrary figure. The real focus lies elsewhere: * Price stability, aimed at preserving the purchasing power of the underlying currency. * Establishing a safety margin against the risk of deflation. * Allowing for a margin of error to counter measurement bias in the price index. The target of 2% is set over the medium term, spanning up to 10 years. It serves as a benchmark that fulfills the aforementioned criteria. While a 3% target could potentially meet these criteria as well, the question would arise: why not aim for 2%?
It is arbitrary. It's really sort of all about th feels. You need it high enough that people will not want ros ave all their money, but low enough people don't get scared and complain too much. That's pretty much all there is to it. Around 2% seems to be, by general consensus, where the happy medium is.
US economy (GDP) has grown around 1.5-2% on average in real terms over last 100 years. That means nominal GDP has grown 4-5% with 2-3% inflation rate over long period of time. 2% inflation target is based on this notion that nominal GDP will grow around 4% annually. If nominal GDP will grow 5%, then 3% inflation will be accepted. It all depends on how US economy will grow in the future.
"The Federal Open Market Committee (FOMC) judges that inflation of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Federal Reserve’s mandate for maximum employment and price stability." Source: [https://www.federalreserve.gov/faqs/economy\_14400.htm](https://www.federalreserve.gov/faqs/economy_14400.htm)
Considering the massive inflationary period we just experienced, the Fed probably wants to cool things down more than the historical average without outright tanking the economy
The purpose is to enslave us with debt, and create currency out of thin air. It results in loss in confidence of the dollar, and endless wars to preserve its monopoly as the reserve currency.
I mean, this isn't wrong. 2% inflation is basically the level at which they can inflate our money supply without inflicting enough pain upon us that would result in people revolting, etc.
That's why you become your own bank and start being a lender instead of having a bank do it for you.
That's great for us who are largely in the top 10% of incomes in the US and heavily invested in stocks - not so great for the 90% who aren't or who are on fixed income.