Why Does The US Federal Reserve – And Other Central Banks – Aim For 2% Inflation?

The Fed has two jobs: to maximize employment and to keep prices in the economy relatively stable – and inflation relates most closely to the latter. The Fed says that an inflation rate much greater than 2% per year would, over time, reduce the ability of people and companies to make long-term economic and financial decisions. The speed of rising prices would likely cause people and companies to spend less money – and the economy would suffer. On the other hand, inflation that’s well below 2% suggests the economy is doing poorly: people aren’t getting pay raises and there’s not enough demand in the economy for companies to raise prices. Central banks have therefore settled on 2% as just enough inflation to keep the economy from falling into deflation while not being so much that changes in prices become harmful.