The 2% Inflation Target Regime Should Now Be Retired: Marcus Ashworth

With the end of great inflation scare in sight, it's time the central bank hive mind contemplated what it might learn from the failure of its economic models.

The most obvious lesson: Steering multitrillion-dollar economies to land with laser precision onto a 2% inflation pin needs to be abandoned. Economic and geopolitical uncertainty necessitates a monetary system that can roll with the punches. A flexible inflation range that reflects reality should supersede an unhealthy fixation on one constant. Trying to fit all economic variables around one peg is futile.

I don’t mean that inflation should be allowed to rip. But price targeting could be put back where it belongs — as part of a wider monetary policy toolkit, not the one-tool-to-rule-them-all. The better solution lies in a combination of fiscal policy restraint and using a selection of monetary instruments — back to the future, if you will, as ranges used to be the norm. Happily, there is a recent precedent that the Federal Reserve trialed in the early part of Chair Jerome Powell's tenure.

Flexible Average Inflation Targeting was introduced by the Federal Open Market Committee in August 2020. It was abandoned amid the pandemic and surge in energy prices before it really had a chance to embed. Its initial aim was to allow the economy to run a little hot if the preceding period had been of too-low inflation, or indeed vice versa. No doubt with hindsight there may have been some drawbacks but a calm dissembling of what could work better in a more normal environment would be practical.

An external energy inflation shock evidently meant it wasn't the right time to fiddle with a new monetary regime. Now that it's subsided, a rethink is in order. A gradual wider range could deliver more predictable results. This could be tweaked if changing economic conditions dictated — without upending the benefits that rigorous inflation targeting have afforded for commercial and investment planning.