No. of Recommendations: 18
2% inflation is a reasonable OUTCOME. It should not be a goal.
There are *extremely* good reasons to have a 2% goal, not a 0% goal. That is why they have it as a goal, not because an average of 0% was too difficult.
The first and biggest reason is that deflationary risk to an economy is FAR greater than inflationary risk, because you can get stuck in deflation for long periods, like spinning your wheels in mud. So a slight undershoot of a 2% target by 1-2% is OK, but an undershoot of a 0% target can become disastrous.
The second is that many prices are too sticky. For example, consider the wages in a slowly dying industry. Maybe the work of those workers is really only worth a few percent less than it was previously, and the best allocation of people and resources within the economy is to have those folks gradually move to another activity. The most rational outcome for both that company and the country is for them to have a slight cut in real wages. But people (and employment contracts) pretty much completely eliminate small pay cuts as a possibility, meaning they get overpaid for the value of their work, and both that company and the economy suffer. Thus a little bit of inflation acts as a lubricant: at for example 2% inflation, the growing firms will offer 2% (or more) increases in the pay they offer, and the stagnating firms will keep nominal wages the same (small and relatively painless real pay cuts), slowly tempting workers to move to other industries.
Is there a better idea? Not that anyone has tried yet.
Some recent research, which I find somewhat compelling, is to target a given *nominal* economic growth rate rather than targeting inflation at all. When the economy is cyclically weak and therefore real growth is weak, you'd allow more inflation so that the nominal growth rate stays up near where you want it: a loose and expansionary fiscal/monetary stance. When the economy is booming and overheating, with unsustainably and dangerously high real rates of growth, you'd target much lower or zero inflation (restrictive policies) so that the nominal growth rate doesn't exceed the real one. One advantage of this is that it's easier to measure and react to the nominal economic growth rate than it is to see the current inflation level, so if nothing else you mostly eliminate misreadings of the data.
Jim
