2% inflation, the cornerstone of central banks, has been put to the test

By Howard Schneider, Balazs Koranyi and William Schomberg

WASHINGTON (Reuters) – Major central banks, which have linked the 2% inflation target to entrenched price stability, are seeing that monetary policy dogma face its first real test with the recent burst in prices.

By setting an inflation target, central banks think they will give themselves credibility and better guide the thinking of households and businesses. Inflation targeting has spread across the developed world, from New Zealand in 1990 to the United States and Japan in 2012 and 2013, respectively, and Europe.

But since the start of the COVID-19 pandemic and Russia’s aggression against Ukraine, this monetary policy framework has been shaken like never before.

“In the future, we may face a period of structurally higher inflation than in the last two decades. The deflationary effect of economic localization is disappearing and there will be inflationary pressures from global trade, climate transition, demography and politics,” said Claudio Boric. Head of the monetary and economic department at the Bank for International Settlements (BIS).

Claudio Boric is not in favor of raising inflation targets despite the recent rise in prices, which could be more persistent than expected and make it harder to orchestrate a return to 2% inflation.

At this stage, the biggest concern of the world’s big money-making companies is losing credibility if they do not respect the course of action they have set.

US Federal Reserve Vice Chairman Lael Brainard asked earlier this month, “Is 2% some kind of magic number?” he said. “Probably not. But this is our figure and we are very committed to reducing inflation to 2%… Achieving this goal is the basis of our general monetary policy,” he added, repeating the views shared by the central banks. euro zone, UK and Japan.

“Let me be absolutely clear, there are no ifs or buts in our commitment to a 2% inflation target,” the governor said last year. Bank of England, Andrew Bailey. “It’s our job and we’re going to do it.”


At its monetary policy meeting on Tuesday and Wednesday, the Fed is expected to commit to 2% inflation, the “most consistent long-term” rate with price stability, as it has done every year since 2012, as mandated by the US Congress. and full employment.

Although the central bank has made significant changes to its “statement of long-term objectives and monetary policy strategy”, it has never called this target into question on the grounds that a word is a promise and can only be renegotiated at great risk.

Although currently the global standard, the 2% figure is the result of a more in-depth analysis or statistical evaluation than a best estimate of the rate that would allow issuing institutions to achieve the benefits of targeting, low enough for people. .

Emerging from the period of hyperinflation in the 1970s and 1980s, managers felt the need to strengthen their credibility in the fight against rising prices and saw a simple way of communication to guide expectations and build confidence in target setting.

There is widespread agreement that a modest increase in prices is economically justified. It allows companies to adjust “real” wage costs without slowing hiring, and allows central banks, thanks to higher nominal interest rates, to manage economic downturns through rate cuts rather than bond purchases and other less traditional measures.

Under political pressure to prevent high inflation in the 1980s, New Zealand’s central bank first floated the idea with a target of between zero and 2%.

“It wasn’t the most scientific process in the world,” said Michael Reddell, a former economist at the Reserve Bank of New Zealand. “No one has done this before us.”

“I personally think that number made sense based on history, experience and research … It has served us incredibly well,” New York Fed President John Williams said earlier this month. “It helped with transparency. It helps markets and people understand what our North Star is.”

However, the debate continues as to what will happen if this target becomes more of an untouchable symbol than a real target.

Economists and central bankers do not expect inflation to moderate at a rapid and steady pace. Some even think that the current phase is the easiest phase, especially with the initial drop in prices without serious consequences for labor markets.

But despite the focus on returning inflation to 2%, officials also acknowledged that discussions could become more difficult as they assess the past and future impact of rate hikes on the economy, inflation and the economy.

The rapid rate hike “was really important to demonstrate that resolve and to get people to understand that 2% inflation is still the right anchor,” said Lael Brainard. “We are in a slightly different position today… We are now in such an environment that we have to balance the risks of both sides.”

Fed officials have predicted that their monetary tightening measures could result in the loss of 1.5 million US jobs this year. If inflation is firmer than expected, hitting the 2% target could be more painful.

While the latest data suggest a “slightly better outlook” for an outcome where inflation slows toward the target without significant damage to jobs or growth, Lael Brainard said: “It’s a very uncertain environment and you can just rule out worse trade-offs. you can’t.”

(Reporting by Howard Schneider in Washington, Balazs Koranyi in Frankfurt and William Schomberg in London; Reporting by Lucy Craymer, Michael Derby and Leika Kihara; French version by Laetitia Volga, Editing by Kate Entringer)

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