In 2012, the Federal Reserve publicly and formally declared for the first that it was pursuing an inflation target of 2 percent, a framework that guides and explains its decisions on short-term interest rates and other monetary policy tools. Today, that decision is under scrutiny, both outside and inside the Fed. The minutes of the December 2017 meeting of the policy-making Federal Open Market Committee (FOMC) note, “Due to the persistent shortfall of inflation from the Committee’s 2 percent objective or the risk that monetary policy could again become constrained by the zero lower bound, a few participants suggested that future study of potential alternative frameworks for the conduct of monetary policy…could be useful.”
Should the 2 percent inflation target framework be kept, changed or replaced? If the current framework is to be replaced, then with what? The report, “Rethinking the Fed’s 2 percent inflation target” (PDF), is drawn from a conference convened by the Hutchins Center on Fiscal & Monetary Policy at Brookings and summarizes the debate over answers to those questions. The full report is available here or scroll down to read individual chapters by David Wessel, Lawrence H. Summers, and John David Murray.
David Wessel describes the arguments for keeping, changing or replacing the Federal Reserve’s 2 percent target, and the pros and cons of each of the alternatives that have been proposed—including raising the inflation target or replacing it with a price-level target or nominal GDP target. Read Wessel’s report here.
Lawrence H. Summers reviews the history behind the choice of a 2 percent inflation target and argues that the logic applied when it was chosen mandates a higher target today. He also explains why he finds the broad “new Keynesian” framework in which most discussion of monetary policy is carried on to be unsatisfactory. And finally, he argues that the current 2 percent inflation target framework makes it very likely that the next recession will come sooner and be more protracted than is necessary as well as putting excessive pressure on fiscal policy. Read Summers’ report here.
In 1991, the Bank of Canada was the second central bank – the Reserve Bank of New Zealand was the first – to adopt an inflation target as its primary monetary policy strategy, replacing earlier frameworks that relied on the exchange rate and the money supply. The target is set jointly with the government, and the framework is reviewed every five years. John David Murray, a 34-year veteran of the Bank of Canada, discusses the bank’s experience with the inflation target, and why the framework likely won’t be changed any time soon. Read Murray’s report here.