Chasing 2 Percent Inflation: A Really Bad Idea

by John Chapman

In just two years, inflation targeting (namely, the quest for 2 percent inflation) has gone from the lunatic fringe of economics to mainstream dogma. Much of the allure springs from notions that a little inflation motivates people to speed up spending, thereby greatly increasing the efficacy of central bank stimulus. It is touted as a cure for sagging demand and a defense against the (overly) dreaded deflation.

Other benefits include melting away some of the massive government and private debts and improving people’s perception of progress as they see their nominal wages rise. Employers can lower real wages without unpopular dollar pay cuts. The Fed can allow price increases to signal the need for production responses, allow for minor supply shocks and for monopolistic industries to increase prices all without a monetary response that would hurt other elements of the economy.

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