# What is the rationale for setting a 2% target rate for inflation

I have what I think is a simple question, but just like 'how do you balance a checkbook' they don't teach it in school.

Is there any scientific proof that 2%-3% target inflation rate is ideal?

and that's a different question, it assumes 2%-3% inflation.

My question is simple: what is the rationale for assuming that any inflation at all is a good idea.

From what I understand, some amount of inflation:

1. makes the money you pay back your 30 year mortgage with (and any other long term loans) cheaper, so you're not really paying back your whole loan in the same full value money in which you borrowed it. yay, score one for the little guy.

2. means that unless you get an inflation-rate raise every year, you are taking a paycut. minus one for the little guy. This has the advantage of making it easy for every employer to pay their workforce less every year, by simply not giving everybody an inflation rate raise.

3. makes things appear to depreciate more slowly. Let me see if I get this right: A \$1,000 car devalues as soon as you drive it off the lot, so in 2 years it's worth a smaller dollar value because it is a slightly worn car (let's say \$800 in original-purchase-dollars value) but because of inflation it's worth \\$820 in 2-years-after-purchase money because each dollar is worth a little less so you need more of them to express the same actual value.

I'm sure there are lots of other side effects, but those are the big ones that stand out to me.

But my actual question is: why at all?

Imagine a world where a gallon of milk always costs the same amount (varying for supply demand problems, in which case the price wouldn't just slow its increase when supply improved, but would actually go down to its original actual-cost price.)

Imagine you received the same compensation for the same work year after year, and that was okay because goods and services cost roughly the same thing every year and you could afford to exist in this static, status-quo world.

I've read about the 2% inflation target for decades now but have yet to find an explanation why it is assumed to be good.

I sometimes think it makes the humans feel better by getting a 'raise' every year and having a paycheck with a bigger number in it every year. Like giving a kid a present at Christmas, it makes you feel better to have more stuff, bigger numbers. That's why games have scores and higher scores are assumed to be better. That seems somewhat reasonable, but I have a little more faith in at least some of humanity that that doesn't make the whole inflation enterprise justifiable.

I realize inflation is natural and will occur as a result of supply and demand problems like what we're seeing today (at the end of 2021 for you future readers.) What I don't understand is where the assumption that an above-zero inflation target is the best deal overall.

Maybe a 2% drop would be better. Maybe I want the value of all my saved dollars in the bank to be worth more so I can retire more easily and not have to worry that my money will evaporate while I'm in retirement, but in fact be worth more. score one for the little guy.

So... what am I missing. What day of school was I out sick for where they explained this, because I don't get it. Maybe it really is simple, and I'm just not seeing it, but I really just don't see the value of assumed-inflation.

– 1muflon1
Commented Dec 24, 2021 at 12:26
• well, it supplies some arguments but I think what it really says is that I covered some points, they covered some points, but what it really shows me is that: nobody really knows in entirety. we only know a few major effects that drive the rationale. The "wages are sticky" point is sadly close to my "people like higher scores" and maybe that's the most valuable point, but given the hundreds of years of economic study the fact that everybody seems to coalesce around a few points but not really have a solid deterministic answer means there probably isn't one. I guess economics is squishy.
– stu
Commented Dec 24, 2021 at 13:18
• A target of negative 1 might cause a recession when people delay purchases because they expect lower prices. A target of zero risks being negative so it is only a little different. The recession would be a transition period. At some point consumers cannot delay purchases any longer. Commented Dec 24, 2021 at 19:34
• Does this answer your question? Is zero inflation desirable? Commented Dec 24, 2021 at 20:30
• partially. it seems to come down to the same thing: there's lots of apparent and not so apparently purposes to various values of inflation to be targeted, (2 or 0 or 4 or whatever), and they all have even more knock-on effects. so it answers my question in that yes there are lots of reasons for one way or another, but no, there isn't really A single answer.
– stu
Commented Jan 3, 2022 at 19:10

This is answered in Olivier Blanchard's Macroeconomics 2021 8th edn, starting at p 491ff. I quote just his conclusion on pp 495-496.

## The Optimal Inflation Rate: The State of the Debate

At this stage, most central banks in advanced economies have an inflation target of about 2%. But they are being challenged on two fronts: Some economists want to achieve price stability—that is, 0% inflation. Others want, instead, a higher target rate of inflation, say 4%.
Those who want to aim for 0% make the point that 0% is a different target rate from all others; it corresponds to price stability. This is desirable in itself. Knowing that the price level will be roughly the same in 10 or 20 years as it is today simplifies a number of complicated decisions and eliminates the scope for money illusion. Also, given the time consistency problem facing central banks (discussed in Chapter 21), the credibility and simplicity of the target inflation rate are important. Some economists and some central bankers believe price stability—that is, a 0% target—can achieve these goals better than a target inflation rate of 2%. So far, however, no central bank has actually adopted a 0% inflation target.
Those who want to aim for a higher rate argue that it is essential not to fall in the liquidity trap in the future, and that, for these purposes, a higher target rate of inflation, say 4%, would be helpful. They argue that the choice of a 2% target was based on the belief that countries would be unlikely to hit the zero lower bound, and that this belief has proven false. Their argument has gained little support among central bankers, who argue that if central banks increase their target from its current value of 2% to 4%, people may start anticipating that the target will soon become 5%, then 6%, and so on, and inflation expectations will no longer be anchored. Thus, they see it as essential to keep current target levels.
The debate goes on. For the time being, most central banks continue to aim for low but positive inflation—that is, inflation rates of about 2%.

• so what I'm getting from all this is that lots of people have lots of ideas, but nobody really has a good solid reason why 2% (or 0% or 4%) is objectively a good idea. I'd make the argument that 0% makes some simple sense, why wouldn't a widget today cost the same as a widget tomorrow, but I'm not an economist, what do I know.
– stu
Commented Dec 28, 2021 at 23:37