We are all aware of inflation. It eats away at our financial life.
So if inflation is bad, why does the Federal Reserve aim for a 2% rate? Why not aim for a 0% rate?
Richmond Federal Reserve published this statement:
“…the ability of policymakers to boost economic activity through interest rate cuts during periods of low inflation. Cutting rates becomes difficult when interest rates are already near zero, something known as the zero lower bound problem.”
Basically, the reason there is a non-zero percent target is so that the Fed has the ability to raise or lower interest rates as they see fit. If inflation were near or at 0%, then the Fed could not lower rates, as there is no rate less than zero.
Aside: There is a less than zero rate, but for the U.S. it might be untenable. During the low inflation period we recently exited, some economies implemented negative interest rates. “Negative interest rates mean that borrowers are credited with interest when they borrow money instead of being charged it.“
It seems doubtful that this would fly in the U.S., but since inflation has picked up since they went into effect overseas, negative interest rates are now moving out of vogue.
Switzerland, Sweden, Denmark, and Japan all implemented negative interest rates at one time or another.
Purpose
The purpose of the 2% inflation target is to allow the Federal Reserve to be able to set an interest rate lower than the inflation rate if it felt appropriate. If the goal is 2%, then the Fed has the flexibility to set rates at or above or below 2%, as it sees fit.
If inflation were say 0%, then the Fed could not lower rates below 0% if it so desired. This limits its ability to set whatever rate it wants.
Conventional wisdom say that borrowers like inflation because they are said pay back their loans wih “cheaper” dollars. Unfortunately, they need to pay back more of them, so seeing a positive in this situation is difficult.
This brings us to the following conclusions:
— Inflation is a goal of the powerful.
— The detrimental affects of inflation on you and me and everyone else are sacrificed so that the Fed has the ability to someday lower interest rates. (I call this the “just in case inflation.”)
— The fact that it is a “someday” thing means the ability to set low rates can be hypothetical, despite the real destructiveness of inflation.
There is no escape for us from the affects of inflation, so we best be prepared.
How to protect oneself from the destructive effects of inflation?
Owning assets that have the ability to appreciate during inflationary times. I’ve named these “inflationary assets.”
Surviving inflation? Let me know here.
Illustrated is a map of Philadelphia in 1752. Courtesy Library of Congress.
The post Why Is 2% The Federal Reserve’s Inflation Goal? appeared first in Smile If You Dare.