When we talk about sound management of the economy, we often refer to a target inflation rate, for the majority of central banks, of 2%. I would like to know the arguments justifying this rate. Why isn’t it 1% or 3%? –Ernest Desrosiers
Central banks in industrialized countries adopted a 2% inflation target fairly recently, says National Bank economist Jocelyn Paquet, whom we asked to help answer your question. It appeared in the 1990s, when inflation became a problem in most countries. Uncontrolled inflation, he recalls, is very harmful to the economy because consumers rush to consume for fear that the prices of goods will continue to rise, which will accelerate inflation, while companies are slowing down their investments because it is costing them more and more.
The quest for a certain price stability has therefore emerged as the necessary ingredient for economic growth, with the corollary of setting a target that would ensure this stability.
So why 2%? The New Zealand central bank was the first to decide that 2% was an acceptable target, explains Jocelyn Paquet.
This target could not be zero, he said, because central banks need leeway to intervene effectively in the event of a crisis with their main tool, the setting of interest rates. “If the target is zero, in the event of a recession, central banks could be forced to set negative interest rates, leading to other problems like deflation. »
Similarly, a higher target of 4%, 5% or 6% may have the effect of pushing inflation higher. “A high rate of inflation usually leads to high inflation,” says the economist.
The 2% target was therefore considered adequate, and the Bank of Canada first adopted it in 1991, followed by the Bank of England and, more recently, the US Federal Reserve.
Aiming for an inflation rate of 2%, more precisely a price variation contained within a range of 1% to 3%, has proven to be a good strategy for Canada. Over the past 30 years, prices have remained within this range, and the wheel of growth has turned smoothly.
With the reappearance of inflation last year, more and more voices are being raised to say that this threshold should be raised to take into account the more inflationary economic context, due in particular to the aging of the population and climate change.
It would be a mistake to change the inflation target now, says the National Bank economist. “The effectiveness of monetary policy depends on the credibility of monetary authorities. Changing the inflation target in the midst of a fight against rising prices would send the message that central banks are unable to meet their commitment to return to the 2% target,” he explains.
Whether or not to raise the inflation target is certainly debatable, he said, but central banks must first prove that they are capable of bringing inflation back to target. Even if it hurts. Because changing their commitment along the way could hurt even more.
