Fed's 2% Inflation Target Faces Growing Scrutiny

The Federal Reserve's inflation target of 2% is an anomaly that has been perpetuated by the institution, despite the lack of evidence to support it. The origin of this target dates back to a 1988 remark by Finance Minister Roger Douglas on New Zealand television, where he mentioned bringing down inflation to 'around 0 to 1 percent.' This was later codified into monetary policy orthodoxy.

A survey of 600 economists found that more than half would keep the current target, citing the 'credibility cost' of changing it. However, this is seen as a classic example of institutional behavior: refusing to correct an error for reputational or credibility reasons.

Fed Chair Kevin Warsh's recent speech at Jackson Hole noted the importance of humility and not being naive in monetary policy decisions. Yet, the Fed has failed to adapt to the new economic conditions brought about by the pandemic, which has scrambled supply chains and shifted consumption habits.