Federal Reserve Building, Washington DC
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The Fed wants to keep inflation down to 2%. But the economy could be fine with higher inflation.
- HSBC, Europe’s largest bank by assets, reported fourth-quarter pre-tax profit of $5.2 billion. That’s a 108% jump year over year, beating analysts’ estimates of an 87% rise. More good news: The bank is one of the few companies to be upbeat about its performance this year.
- Markets in the US were closed for Presidents Day on Monday, but stock futures fell overnight. In Asia-Pacific, markets traded mixed on Tuesday. Japan’s Nikkei 225 fell 0.23% as the country’s Flash PMI fell to 47.4 in February, signaling a decline.
- The US Federal Reserve – and many other central banks around the world – have announced their determination to bring inflation down to 2%. But it’s an arbitrary target that some economists have criticized.
- PROFESSIONAL The US economy could avoid a recession this year – or crash. These stocks make investors “expect for the best…but insure themselves against the worst,” according to Goldman Sachs.
The 2% inflation target has been repeated so many times by Fed officials and central bankers around the world that it seems absolutely crucial to a healthy economy. But “the 2% inflation target is relatively arbitrary,” said Josh Bivens, research director at the Economic Policy Institute.
In fact, it was invented in New Zealand in the 1980s. Arthur Grimes, professor of well-being and public policy at Victoria University, said that New Zealand was experiencing skyrocketing inflation at the time and the central bank chose – seemingly out of nowhere – an inflation target so it could work towards a target.
Other central banks followed suit. In 1991, Canada announced its inflation target; the UK followed a year later. It wasn’t until 2012 that the US declared its inflation target of 2%, but since then that figure has stubbornly stayed alive in the Fed’s mind.
But if the 2% target is arbitrary, it means that the economy could function normally at a higher level of inflation. In fact, some economists wrote a letter to the Fed in 2007 advocating a higher ceiling. “There is no evidence that 3 or 4 percent inflation compared to 2 percent inflation does any significant harm,” said Laurence Ball, an economics professor at Johns Hopkins University who was one of the signatories to the letter.
However, the Fed is unlikely to change its target midway through the current cycle of rate hikes – it could look like giving in to investor demands for lower rates. Rethinking what healthy inflation means will be a task left to another generation of central bankers.
– CNBC’s Andrea Miller contributed to this report.
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