The Federal Reserve’s goal is to get the inflation rate at least near 2% before it begins cutting interest rates.
That’s a formal target backed by written policy, but it’s also the source of growing liberal discontent serving as another form of political pressure on Fed Chair Jerome Powell as he tries to navigate a white-hot election year.
Some on the left want that number to be higher. Some would prefer the Fed add a second target focused on the labor market. And several Democrats used public hearings this past week with Powell to question the target’s origins and why it has so much importance inside the central bank.
“It seems to come from Auckland and from the 1980s” a somewhat disbelieving Rep. Brad Sherman said Wednesday when it was his turn to question Powell.
The liberal stalwart from California was right. The path to 2% began with an off-the-cuff comment in New Zealand in 1988.
The Fed publicly adopted the standard 24 years later, in 2012, in a process that was met with discomfort from the left side of the political spectrum largely because of the lack of a parallel labor market target.
Senator Sherrod Brown, chairman of the Senate Banking Committee, underlined this dynamic Thursday when he suggested Powell move quickly to cut rates “to prevent workers from losing their jobs” and added that “this town too often seems to forget that maximum employment is part of the Fed’s dual mandate.”
The Fed doesn’t have a numeric labor target even though its dual mandate requires it to aim for both stable prices and maximum employment.
Its inflation target is key because of how rate cuts are decided. Powell and other Fed officials have made it clear they won’t start lowering the benchmark rate from its 22-year high until they are confident inflation is moving down “sustainably” to 2%.
And Powell strongly signaled this week that the 2% inflation target isn’t going anywhere. He mentioned it seven different times within the span of his five-minute-long opening remarks before lawmakers on both Wednesday and Thursday.
He also acknowledged its Kiwi origins in response to Sherman’s questioning but added that “2% has become the global standard, it’s a pretty durable standard.” He reinforced his belief that it wouldn’t be a problem for the US to achieve the 2% level in the months ahead.
“People are always talking about this,” said Preston Mui, who is with a labor market-focused group called Employ America. Changing the target by moving it even higher to 3% “is probably not something that’s politically in the cards for the Fed at all right now.”
But talking about the number has nonetheless “caused a lot of headaches for Powell over the last two to three years,” Mui added.
How the Fed got here
The path to the Fed’s 2% inflation target was a winding one that began with an interview that is now infamous in central banking circles.
Don Brash, who was governor of New Zealand’s Reserve Bank, offered an off-the-cuff comment in 1988 that he wanted an inflation rate between 0 and 1%. That set off a policy-making process and led his nation to adopt a formal 2% target soon thereafter.
Other central banks followed and the moves were criticized from some quarters as being too inflation-focused.
Perhaps the most colorful takedown came from Mervyn King, a British economist who served as governor of the Bank of England. He said in 1997 that he worried a hyper-focus on price targets would lead to central bankers becoming “inflation nutters.”
The Federal Reserve, under Alan Greenspan at the time, was resistant to a public embrace of the idea but debated it throughout the 1990s and early 2000s.
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