The Federal Reserve’s current inflation target of 2% (on average) has been in place since 2012 when the Federal Open Market Committee voted to adopt it as the official policy. But with the US economy still struggling to make a full recovery from the depths of the Great Recession, some experts have argued that the Fed should revisit its inflation target and consider raising it.
Olivier Blanchard, the highly regarded macroeconomist and former chief economist of the IMF, recently argued for an upward revision of the Fed’s inflation target, suggesting that it should be 3%. He believes that a higher inflation target could help the US economy get back on track and spur economic growth.
However, there are concerns about the potential risks of a higher inflation target. First, a higher inflation target without higher potential growth may itself create an economic-downturn trap that the proposed solution seeks to avoid. Second, inflation targets that are similar in magnitude across developed and developing countries may have significant implications for international financial markets and capital flows.
For example, a higher inflation target in the US could lead to a flight of capital from other countries to the US, leading to capital outflows from many developing countries. This could adversely affect economic growth and development in these countries while providing little benefit to the US economy.
Moreover, a higher inflation target could lead to a destabilizing effect on global markets. When the Fed sets its inflation target too high, it could increase the cost of borrowing for both businesses and consumers. This could lead to higher prices and lower demand for goods and services, which could potentially lead to a recession.
Finally, a higher inflation target could also lead to higher interest rates and a weaker US dollar, both of which could lead to financial instability in other countries. This could lead to an increase in global uncertainty and potentially derail global economic growth.
Therefore, while the potential benefits of a higher inflation target should not be underestimated, it is important to consider the potential risks and unintended consequences that could result from such a move. It is important to have a clear understanding of what the potential effects of such a decision could be and to weigh the costs and benefits carefully. Only then can the Fed decide if a higher inflation target is the right course of action.
