(playful music) (darts hitting)
- [Narrator] For the Federal Reserve, controlling inflation
is a little like playing a game of darts,
just scored differently.
It uses its tools to aim
for that bullseye, which in this case is.
- 2%.
- 2% inflation target. - 2% target.
- [Narrator] And just like with darts,
the Fed doesn't always hit the center.
- The process of getting inflation back down
to 2% has a long way to go.
- [Narrator] But even getting close
can help keep inflation in check.
Here's how 2% became the Fed's bullseye
and why that number can help guide the health
of the entire economy.
So where did the Fed come up
with this target in the first place?
The answer, New Zealand.
Suffering from persistent inflation in the 1980s,
the country's reserve bank initially set an inflation target
between 0 and 2%.
- Central banks didn't use to tell people
what they were doing, and in the 1990s,
they began to experiment more with, "Hey,
if we tell people what it is we're actually trying to do,
then maybe it'll make it easier
for us to achieve those goals."
- [Narrator] It's a strategy called anchoring.
When consumers and businesses know
where inflation should run,
it's easier for them to set prices
and spend in a way that's consistent with that goal
and that then helps the Fed set policies
to maintain that level of inflation.
Think of it as the bullseye
at the center of the Fed's monetary policy.
- If you think prices are gonna be higher in a year,
you'll demand higher wages now.
So there can be a self-fulfilling element
to inflation expectations.
- [Narrator] Though targeting has been
in the Fed's conversation for decades,
the US only officially adopted inflation targeting
in 2012 when the Fed was chaired by Ben Bernanke.
- Clearly communicating to the public this 2% goal
for inflation over the longer run
should help foster price stability
and moderate long-term interest rates,
and will enhance the committee's ability
to promote maximum employment
in the face of significant economic disturbances.
- [Narrator] So what's so special about the number two?
- There isn't a lot of empirical research
that says we've analyzed all the different outcomes
and 2% is the right number for these reasons.
That's really not how central bankers came up with 2%.
The idea was you wanted to have a a level of inflation
that was low enough that people wouldn't pay attention
to how high prices were going up.
- [Narrator] For the Fed,
the number two achieves a few things.
For starters, it's not so low
that the economy risks deflation, which is when prices fall
and can lead to lower wages and higher unemployment.
The economy was at risk for deflation
during the Great Recession between 2007 and 2009.
- Falling prices for a central bank can actually
be a worse state of affairs than rising prices
because if people think prices are gonna be lower tomorrow,
they won't spend today
and that can be very hard to get out of.
- [Narrator] Lower inflation also reduces the Fed's ability
to lower interest rates
because rates tend to move together with inflation.
- If you have a 0% target,
you'll probably have lower interest rates
and the concern would be you'd have less room
to stimulate the economy when you go into a recession.
- [Narrator] But 2% is also thought of as not too high.
High inflation can weaken consumers' spending power.
- The concern would be
that inflation might actually creep too high
and then you'd get into a world
of self-sustaining price increases
where higher prices feed on themselves
and that's a cycle the Fed doesn't wanna find itself in.
- [Narrator] The Fed wants inflation to hit as close
to 2% as it can over time to maintain a healthy economy.
But sometimes it misses.
Through the 2010s, some economists were concerned
that inflation was consistently running too low.
A new policy in 2020 called
flexible average inflation targeting tries
to account for some of those periods.
Rather than always aiming for the bullseye,
the Fed tries to set policy to balance out periods
of lower inflation with periods of slightly higher inflation
with the goal of averaging out at 2% over time.
- The worry was that the anchor
on inflation expectations was actually drifting too low.
And so you could recenter it by saying, look,
we really wanna make sure people don't think 2%
is a hard ceiling.
It's a target.
If we're below it for a little while,
we can be above it somewhat for a little while.
- [Narrator] But not everyone agrees
with the Fed's 2% target strategy.
One concern is that monetary policy is imprecise.
- You know, monetary policy's a blunt instrument.
This is more
like going to see a barber than having a surgery.
- [Narrator] Some also argue that a higher rate of inflation
leaves more room for the Fed to adjust interest rates
to avoid a recession.
Whether or not inflation targeting is actually effective
is difficult to measure.
Inflation did settle for a time after the policy
was implemented in New Zealand in the '90s
in conjunction with a number of other measures,
and it's still relatively new in the US.
- As we've discovered,
there are shocks that can hit the economy
and it's difficult to judge in real time I think
whether this is the right strategy.
- Currently, the Fed reviews the framework
of its monetary policy every five years.
- The idea that the Fed would make some kind of change
to its inflation target in the next couple of years seems
like a big stretch, but they could debate at the margins,
are there different nuances
that our formal strategy document hasn't captured?
And those are the sorts of things
that you might expect to see in the deliberations
around any further review of the framework.
- [Narrator] But for now.
- 2%.
- [Narrator] Remains the bullseye it will keep aiming for.
(playful music)