How a Desire to Get Home for Christmas Dictates Interest Rate Policy

America is being held hostage.

By a number.

That number: 2%.

Now, I wish I could tell you that I’m talking about 2% milk, which is an abomination and an afront to mama cows the world over.

Alas, I’m talking about the Federal Reserve’s bat-outta-hell pursuit of a “2% inflation target.”

You can’t read a financial-news story or listen to any financial TV-show topic about inflation without reading or hearing some reference to “the Fed’s 2% target.”

But did you ever wonder, “Why 2%? Why is that number so dang magical?”

There are economists who will argue that 2% is the rate of inflation that best guarantees price stability, which is one of the Fed’s two mandates. The other: Maximum unemployment. Apparently, those two in a love nest will create economic nirvana and bestow upon all of us a magical life of gently rising prices, limited risk of economic dyspepsia, and jobs until the cows come home (at least those not pissed about adulterated milk).

And I’m sure you’re inclined to believe, as an economist one told me, that it’s all rooted in deeply researched academic words that most of use wouldn’t understand because these are deeply research academic words. Not your basic, “Honey, we’re almost out of inflation; I’m heading to Super Target – do you need anything?”

Ahhhh, dear reader, the truth is more comical.

Prior to the 1990s, no central bank in the world had ever heard of a 2% inflation target, and none were pursuing such a unicorn. Indeed, there was precisely zero research—as in nada, zilch, and bupkus—demonstrating that 2% is an ideal inflation target.

Instead, there was an TV interview…

In New Zealand.

And a farmer/banker who wanted to get home for Christmas.

We’re going back now to 1989. The Kiwi Country Down Under had gone through a nasty bout of inflation that had stretched across two decades. By the late-80s, inflation had slipped to “just” 10% from the mid- and high-teens. During a TV interview, a news anchor pressed New Zealand’s then-finance minister, Roger Douglas, about that level of inflation and whether the government was satisfied with its decline.

Douglas said 10% was obviously still too high, and in an off-the-cuff moment said that, ideally, he’d like an inflation rate of between zero to 1 percent.

At that time there was no set inflation target in New Zealand… or anywhere else in the world.

Months later, the NZ government was in heated discussions about codifying unwritten laws to ensure the central bank’s independence. Inflation-targeting emerged as one of the primary points of contention—odd because it had no place in the original bill.

The law passed, but the fight over what inflation rate to target was contentious. What is an appropriate rate? Zero percent? Two percent? Three, four, five percent?

No one knew.

Why?

Because no researcher had ever conducted any research on this, anywhere in the world!

New Zealand’s new central banker, a farmer named Don Brash, and its new Finance Minister, David Caygill, were eager to get home for Christmas. So, to stop all the arguing, they simply plucked a 0% to 1% target rate out of thin air because of what Roger Douglas had said in that TV interview. Ultimately, they agreed to a 2% rate to ensure more flexibility in policy decisions.

Soon thereafter, both Canada and the U.K. officially adopted a 2% rate. Federal Reserve pooh-bahs never officially adopted that rate until January 2012, when Ben Bernanke was drunkenly steering the ship, but the Fed was quietly pursuing that goal during the Alan Greenspan years, when the Fed was so tightlipped about its maneuvers that journalists and traders tried to divine the Fed’s actions by the way Greenspan spoke or even how he carried his briefcase.

And that’s the story of the 2% inflation target.

The whole shebang is based on off-the-cuff commentary and a desire to get home for a good ol’ fashioned Kiwi Christmas.

Now, we’re apparently stuck with it.

And that just means we’re stuck with a Fed and its bat-outta-hell pursuit of an inflation target rooted in nothing.

Good to know, isn’t it?

I mean, it’s not like the Fed has ever been wrong, right?

I mean, they had nothing to do with worsening the Great Depression… And they were clearly not at fault for the inflation of the 1960s that forced the U.S. dollar off the gold standard… And they’re clearly not to blame for the fact that the dollar has lost more than 90% of its value to inflation since the Fed was born… And obviously it wasn’t a bad call when Bernanke said the 2007 housing crisis was self-contained… And there’s no way you can fault the Fed for saying that post-COVID inflation was transitory.

Or, just maybe, the Fed is the real menace.

Prepare now for the shoals ahead.