Should we stop at an inflation rate target of 2 percent?

At their recent meeting, the leaders of the Federal Reserve indicated they would likely reduce their key policy interest rate in 2024, perhaps multiple times. If the Fed indeed does this, most interest rates in the economy would also drop. This would especially be good news for households wanting to borrow for big ticket purchases, like homes, vehicles, appliances and furniture. Lower interest rates would also boost economic growth.

The Fed began raising its key interest rate in early 2022 in an attempt to stop the surging inflation rate, which peaked at a yearover-year rate of 9.1 percent in June 2022. Results show the Fed is succeeding. The most recent year-over-year inflation rate for November came in at 3.1 percent.

The Fed has stated on numerous occasions that its goal is an annual inflation rate of 2 percent. This is close to the inflation rate prior to the pandemic. However, the Fed's stated goal raises the obvious question: Why stop at a 2 percent inflation rate? Why not go to zero price inflation, or even better, why not have a goal of negative inflation, meaning prices are falling? These are excellent questions. In today's column, let me try to explain why the Fed wouldn't want to pursue a zero or negative inflation rate and then let you decide if the Fed's reasoning makes sense.