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Does it make sense to ditch the 2% inflation target?

23 January 2023 George Brown, Economist at Schroders
George Brown, Economist at Schroders

George Brown, Economist at Schroders

Investors are beginning to question whether central banks should set their sights higher.

Since the advent of inflation targeting in the 1990s, advanced economies have coalesced around a common 2% goal. In the intervening decades, central banks have largely achieved low and stable inflation. But this has been turned on its head in recent years as inflation has soared to the highest seen for a generation.

This has ignited a debate over whether policymakers should ditch the ubiquitous 2% target and instead set their sights on higher inflation.

Proponents of a 3% or even 4% inflation target argue it would entail higher nominal rates. Higher nominal rates would diminish the risk of central banks being constrained by the effective lower bound, or “ELB”, as they would have more room to reduce borrowing costs when faced with an economic downturn. It is a seemingly simple solution to the issue that has plagued policymakers in the years following the Global Financial Crisis.

But it brings about problems of its own. One is whether inflation will even be able to converge to the higher target.

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