Top central bankers, who credit the use of a 2% inflation target with anchoring decades of stable prices, are facing the first full-on test of how well that approach to monetary policy works once prices have erupted, and how strictly they'll enforce it if damage to their economies intensifies.
By announcing an inflation goal, central bankers feel they build credibility for themselves and focus the planning of households and firms in ways that help keep inflation controlled. It's a concept that seemed supported by the facts as the use of inflation targeting spread across the developed world from New Zealand in 1990 through Europe and to the United States and Japan in 2012 and 2013.
"Looking ahead, we may face a period of structurally higher inflation compared to the past two decades. The deflationary impact of localization is dissipating, and there will be inflationary pressures from global trade, climate transition, demographics and politics," said Claudio Boric, head of the monetary and economic department at the Bank for International Settlements, an umbrella group for central banks.
"Is 2% sort of a magical number?" U.S. Federal Reserve Vice Chair Lael Brainard said at a forum earlier this month. "Probably not. But it's our number, and we are very committed to bringing inflation back to 2% ... Achieving that target is just core to our overall monetary policy," Brainard said, a sentiment echoed in central bank headquarters from Frankfurt to London to Tokyo.
Yet the 2% number, as Brainard suggested, has no particular import in itself. Though now a global norm, it was less a product of deep analysis or statistical estimation than a best guess about an inflation rate that would capture the benefits central banks see in setting some sort of target, while remaining low enough that the public, in effect, wouldn't notice.
While some inflation hawks still argue that level would be zero, there's a broad consensus that modestly rising prices are healthy for an economy. It gives firms a way to adjust "real" labor costs without curbing hiring, and it gives central banks more room, through higher nominal interest rates, to manage economic downturns with interest rate cuts rather than the bond purchases and other less conventional measures used once policy rates hit the zero or near-zero level.
The rapid rate hikes of last year were "really important to demonstrate that resolve and to make sure people understood that 2% inflation is still the right anchor," Brainard said. "We're in a somewhat different position today ... Now we're in an environment where we're balancing risks on both sides."
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