The Federal Reserve’s 2% Inflation Target Faces Political Pressure from the Left

The Federal Reserve has come under scrutiny as calls for change in the inflation target gain momentum. The central bank's target of 2% inflation rate has become a subject of debate, as some voices from the left push for a higher target and the inclusion of a labor market target. This has put Fed Chair Jerome Powell in a challenging position, as he faces growing political pressure in the midst of a fiercely contested election year.

Origins of the 2% Target

The journey to the Fed's 2% inflation target began with an off-the-cuff comment made by Don Brash, the governor of New Zealand's Reserve Bank, in 1988. This seemingly casual remark set off a policy-making process that eventually led to the formal adoption of a 2% target by New Zealand. Over the years, other central banks, including the Federal Reserve, followed suit, despite initial resistance and criticism.

Criticism and Debate

Despite the adoption of the 2% target by the Federal Reserve in 2012, the move has faced criticism, particularly from the liberal end of the political spectrum. There have been calls for a higher inflation target, with some arguing that the current target lacks consideration for the labor market. The absence of a numeric labor target, despite the Fed's dual mandate, has been a point of contention, with some urging for a more comprehensive approach that encompasses stable prices and maximum employment.

The Way Forward

The debate around the 2% inflation target has prompted discussions about potential changes. While some believe that increasing the target to 3% is not feasible in the current political landscape, others continue to advocate for adjustments. Additionally, the Fed's move in 2020 to adopt a flexible average inflation targeting framework aimed to provide more leeway by allowing inflation to run slightly hotter for periods. However, this has not fully assuaged the concerns raised by critics.

Challenges in Implementation

Efforts to add a corollary target focused on the unemployment rate face challenges, as defining a specific unemployment target involves complexities and risks. Some advocate for more nuanced measures beyond the traditional unemployment rate, such as prime age employment rate, wage growth, quit rates, and overall labor force participation. This highlights the difficulty in reaching a consensus on how to address the labor market within the framework of the Fed's mandate.

Political and Economic Implications

The push for changes in the inflation target has significant political and economic implications. With the Federal Reserve's policy under review from later this year through 2025, the debate around the 2% target is expected to persist, especially as calls for rate cuts continue amid shifting economic forecasts.