The Federal Reserve, led by Chair Kevin Warsh, has pledged to restore annual inflation to its target of 2%. This goal has been elusive, with inflation remaining above 2% for 63 consecutive months. To understand why the Fed is committed to this target, it’s essential to examine the history and economic reasoning behind it.

History of Inflation Targeting

The Fed’s price-stabilizing role began in 1977, and in 2012, it officially adopted a 2% inflation target. This target was influenced by other countries, such as New Zealand, which first implemented inflation targeting in 1990. The choice of 2% was not based on exact science but rather on the idea that it would balance price stability with maximum employment.

The Fed uses the personal consumption expenditures (PCE) index to track inflation, which measures prices for a broader range of goods and services than the consumer price index (CPI). Some economists argue that these measures overestimate real inflation, and the Fed chair has called them “imperfect”.

Why 2%?

The 2% target was chosen because it is considered a happy medium between price stability and maximum employment. A higher target would erode purchasing power, while a lower target would risk deflation, reduced spending, and increased unemployment. The Fed’s statutory mandate is to balance these two objectives, and the 2% target is seen as a way to achieve this balance.

Original reporting: KRDO (Colorado Springs metro) — read the source article.