The Fed’s two per cent inflation target has long been a pillar of US monetary policy, but its origins are more arbitrary than economic theory might suggest. This benchmark was first introduced in New Zealand in the 1980s to combat their runaway inflation. The Federal Reserve only adopted it as a formal target in 2012. Yet, as we move further into an era defined by global economic shifts, adhering to this rigid figure may harm more than it helps, not only within the US but also on a global scale.
Current employment data in the US tells only part of the story. Official statistics paint a picture of job growth, but white-collar unemployment remains elevated, and an influx of undocumented workers in cash jobs distorts the real employment picture. The Fed’s reliance on these metrics to justify rate hikes is problematic when higher interest rates create corporate layoffs, particularly in sectors that rely on skilled, well-paid labour. This cascade effect has global implications.
The US dollar is the world’s reserve currency, and a high interest rate in the US puts upward pressure on the dollar, causing challenges for emerging markets, particularly in China, Southeast Asia, and Latin America. In China, a strong dollar complicates exports, as US demand for imports falls when borrowing costs are high, affecting trade balances worldwide. Many emerging economies with debt denominated in dollars find it more costly to service their obligations, forcing budget cuts that can slow growth and erode social stability.
Also Read: Path to profitability: How SEA startups are thriving in 2024’s digital economy
Meanwhile, as the Fed’s two per cent target drives policy in the US, the impact spills over into global capital flows. Higher US interest rates divert investment away from emerging markets, which rely on foreign capital to drive growth and innovation. Countries like Brazil, India, and Indonesia face tougher competition for investment as their borrowing costs rise and growth projections become less stable. As investors flock to dollar assets, emerging economies are left with currency depreciation, inflation spikes, and fiscal stress.
Finally, the real estate and housing markets in the US demonstrate how inflexible targets fall short of understanding global trends. Rate hikes have made homeownership less attainable, increasing demand for rentals, which in turn drives up rental costs. This creates ripple effects in global cities where housing affordability is already a pressing issue. When US policy prioritises a two per cent target without flexibility, it doesn’t just risk domestic instability; it creates vulnerabilities in a globally interconnected market.
If the Fed were to adopt a flexible inflation target—perhaps in the three to four per cent range—it would not only benefit US economic conditions but also relieve some pressure on emerging markets. It’s time to consider whether the two per cent target, rooted in a different era and economic landscape, can adequately serve both US interests and global stability in 2024 and beyond.
—
Editor’s note: e27 aims to foster thought leadership by publishing views from the community. Share your opinion by submitting an article, video, podcast, or infographic.
Join us on Instagram, Facebook, X, and LinkedIn to stay connected.
Image credit: Canva Pro
The post Why the Fed’s 2 per cent inflation target is outdated and harmful to today’s economy appeared first on e27.