How A 2% Inflation Target Became Global Economic Gospel

[interestrateripoff]

http://www.nytimes.com/2014/12/21/upshot/of-kiwis-and-currencies-how-a-2-inflation-target-became-global-economic-gospel.html?ref=business&_r=0&abt=0002&abg=0

Sometimes, decisions that shape the world’s economic future are made with great pomp and gain widespread attention. Other times, they are made through a quick, unanimous vote by members of the New Zealand Parliament who were eager to get home for Christmas.

That is what happened 25 years ago this Sunday, when New Zealand became the first country to set a formal target for how much prices should rise each year — zero to 2 percent in its initial action. The practice was so successful in making the high inflation of the 1970s and ’80s a thing of the past that all of the world’s most advanced nations have emulated it in one form or another. A 2 percent inflation target is now the norm across much of the world, having become virtually an economic religion.

A core piece of the Japanese government’s strategy to jolt its economy to life is to do “whatever it takes” to get to that magical 2 percent inflation level. In the United States, the same rationale has driven the Federal Reserve to keep interest rates near zero for six years and to pump nearly $4 trillion into the economy by buying bonds. The European Central Bank appears on the verge of its own huge effort to bring inflation closer to 2 percent.

Yet even as the idea of a 2 percent target has become the orthodoxy, a worrying possibility is becoming clear: What if it’s wrong? What if it is one of the reasons that the global economy has been locked in five years of slow growth?

Some economists are beginning to consider the possibility that 2 percent inflation at all times leaves central banks with too little flexibility to adequately fight a deep economic malaise.

Perhaps an inflation target is simply moronic especially one that doesn't allow deflation.

[billybong]

That is what happened 25 years ago this Sunday, when New Zealand became the first country to set a formal target for how much prices should rise each year — zero to 2 percent in its initial action.

That's an interesting claim and credited to New Zealand. Maybe it depends on exactly what they mean by "the first country to set a formal target for how much prices should rise each year" (25 years ago - that would be December 1989) because it appears that Germany set what could easily be described as a formal target of about 2% soon after *World War 2 until about 1970 before having to (apparently) relax the target due to the oil crises and monetary policies etc (like a lot of other countries) and then after about 1993 successfully resuming the target. See the link below.

After all during most of the period leading upto 1970 and afterwards when, like now, Germany's economy was continually said to be relatively successful compared to the UK's the UK's PTB were continually insisting that the route to success was via low inflation like they had in Germany and at all costs - but now with UK's low official inflation (despite the fiddled figures and crazy house price inflation) they seem to want overtly high UK official inflation again. Unfortunately the UK's economy is still a debt shambles - come high inflation or low inflation

In those days nobody mentioned New Zealand's possible inflation target(s). Their Commonwealth lamb exports etc yes for sure but inflation target(s) no.

That's not to detract from New Zealand's position and noteworthy achievement in becoming "the first country to set a formal target for how much prices should rise each year" in 1989 but credit also where it's due to Germany for doing something similar and indeed some would say identical soon after World War 2.

http://

www.inflation.eu/inflation-rates/germany/historic-inflation/cpi-inflation-germany.aspx

* World War 2 - officially 1939 to 1945.

Edited December 22, 2014 by billybong

[happy_renting]

Inflation is essentially a tax on cash, savings, pensions, etc.

Leaving aside whether such a tax is reasonable at all, it makes sense for governments to set that tax rate.

It is then left to interest rates & money printing to achieve that target. Interest rates in theory reflect the level of risk to the lender.

[XswampyX]

Yes, but no...

If the government was in charge of the 'money printing' then yes... but they aren't.

Banks create the money. Are you saying they have only created a 2% increase in the total, every year? Really? Only 2%? Are you sure? Maybe? Possibly?

They have created 100% every year, it's only 2% of that that has 'trickled down' to the plebs to drive the 2% inflation.

Why are we getting poorer? They double the money, keep 98% spend 2%, and that drives inflation.

How many pints of milk does the richest man in the world buy? Well one pint like everybody else.

I could cry, boo hoo is me!

The rules are the rules, but the rich and powerful don't play by the rules.

You can't control the money supply by prices if the people with money, have more money than cost of all the items in the world.

That's not to beat on you, I'm just pi$$ed off!

[crash2006]

They just increased tax to compensate for the loss of inflation that would have eroded the debt.

[StainlessSteelCat]

The Undercover Economist Strikes Back makes the case it should be 4% rather than 2% - and reckons deflation is to be avoided at all costs. I was somewhat convinced by the argument to find a Goldilocks zone which was enough to make sure the average person didn't hoard cash because things would be cheaper tomorrow (deflation), but also kept enough faith in it that they barely noticed their pay rises were lagging inflation in the prices of the goods and services they wanted to buy (likely to notice at much higher than 4%). From memory, 2% he argued puts you too close to the danger zone of deflation and doesn't give enough wiggle room - but is not quite high enough for people to lose faith in the currency.

On the other hand, I was also left with the impression that the author had his own very particular economic theory axe to grind, but didn't know enough to be able to tear it apart. For example, it struck me as actually a rather blunt tool and didn't really take into account biflation - seemingly galloping inflation of well above 4% in essential food stuffs, housing and energy (never mind the stealth inflation of smaller sizes or poorer quality) - while the crap you didn't need had at best stagflated e.g. huge chunks of electronic tat.

Edited December 22, 2014 by StainlessSteelCat

[evetsm]

2% is deemed to be the optimal rate of theft that the sheep may not notice

Boil the frog slowly.

btw: the natural economic order is slow, steady deflation as prices fall due to manufacturing efficiency and productivity. Deflation is only a problem in a debt sodden economy and that is only usually a problem when banks can issue unlimited credit. ie inflation and debt overload are problems caused by banks.

[winkie]

My question is: Why are house prices not included as part of this 2% inflation target cap?

[R K]

2% is deemed to be the optimal rate of theft that the sheep may not notice

Boil the frog slowly.

btw: the natural economic order is slow, steady deflation as prices fall due to manufacturing efficiency and productivity. Deflation is only a problem in a debt sodden economy and that is only usually a problem when banks can issue unlimited credit. ie inflation and debt overload are problems caused by banks.

That only holds true if one believes in both constant productivity increases and limitless resource availability (or substitution).

Capitalism sets prices today on the assumption resources are limitless.

If one set the inflation rate to, say, 0%, or -2%, then it wouldnt remove the problem. All it would mean is that governments would be printing actual cash or central bank funded helicopter money on a far more frequent or permanent basis to maintain the rate at 0% or -2% when it fell to, say, -2% or -4% respectively plus all the practical inefficiencies of how to organise an economy & invest when the future return was -ve. Puzzled why people argue that would be preferable.

Edited December 22, 2014 by R K

[Sour Mash]

CPI ran well in excess of 2% for a prolonged period in the last six years, with absolutely no effort made whatsoever to curb it - nor was any concern expressed by the authorities or financial media. This was all at a time when pay rises were non-existent.

Basically, the inflation target is whatever rate of theft those in power reckon that they can get away with. The only rate of inflation that they are concerned with curtailing is the rate of salary inflation for the plebs. That's how you transfer wealth to those at the top.

[Exiled Canadian]

House prices (purchases) are not included in any index. Why?? Well if they were the property I purchased for 3x a decent wage would (I sold recently) for 10x an equivalent salary and so inflation would be MASSIVE and people would want higher wages. Same reason why when comparing wage increases with inflation they 'forget; about tax and NI payments so a 1.7% wage rise is rising faster than inflation of 1.6%.

And before people say it's because houses are infrequent purchases, I have bought more houses in the past 35 years than I have cars!

I agree. A house purchase may be infrequent, but it should be easy enough to impute the annual cost of owning a 3 bed semi mortgage financed with a 10% down payment. Or they could use rents........ Housing cost is rising to being 40% of living costs, any CPI measure that doesn't at least attempt to factor it in is meaningless.