Free exchange

Should central banks’ inflation targets be raised?

The last in our series on the central-bank pivot

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When new zealand’s parliament decided in December 1989 on a 2% inflation target for the country’s central bank, none of the lawmakers dissented, perhaps because they were keen to head home for the Christmas break. Rather than being the outcome of intense economic debate, the figure—which was the first formal target to be adopted by a central bank—owes its origin to an offhand remark by a former finance minister, who suggested that the soon-to-be-independent central bank should aim for either zero or 1% inflation. The central-bank chief and incumbent finance minister used that as a starting-point, before plumping for 0-2%. Over time, 2% became the standard across the rich world.

Should the somewhat arbitrary goal of 2% be changed? The question may seem a little churlish when central banks are so flagrantly missing their existing targets: annual inflation in America, Britain and the euro area, for instance, is running at around 9%. The Federal Reserve’s experiment with “flexible average-inflation targeting” has coincided with the central bank allowing inflation to get out of hand. Yet it is possible that raising the target might help prevent rich countries from returning to the low-inflation, low-growth malaise that was the rule for the decade after the global financial crisis. The idea therefore warrants consideration.

High inflation is painful. Even if wages keep pace with price growth, thereby preserving workers’ incomes in real terms, it undermines the function of money both as a unit of…