THE FED AND INFLATION: ORIGINS OF THE 2 PERCENT TARGET RATE

The following information was released by the Federal Reserve Bank of Atlanta:

Nowhere is the number "two" more debated these days than in the 2 percent inflation target set by the Federal Reserve.

Other uses of "two" spur plenty of arguments, such as the two-minute warning in football and the account of animals boarding Noah's ark two by two. But the 2 percent inflation target that guides the Fed's economic policy making is in a class by itself.

This debate, which can become heated, centers on actions the Fed takes to induce a 2 percent annual inflation rate across a wide range of goods and services. In order to comply with its congressional mandate to foster price stability and maximum employment, the Fed's rate-setting Federal Open Market Committee (FOMC) would raise the federal funds rate to tame spending when rising prices drive the inflation rate above 2 percent; conversely, the FOMC would reduce the fed funds rate if inflation falls materially below the 2 percent objectiveespecially if the employment side of the dual mandate is at risk. (The federal funds rate, often referred to as the fed funds rate, is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.)

Rates on many types of consumer loans and credit lines are influenced by the fed funds rate. By influencing consumer spending, the Fed influences the broader economy over time.

The question of how 2 percent became the US central bank's inflation target has emerged as a national conversation. The question is a persistent one, and answering it can be tense. One example of the tension over the target rate occurred in October 2025, when President Trumpwho at the time was calling on the Fed to lower interest rates to spur the economysaid that a headline inflation rate at the time of 2.7 percent was "almost a perfect number." The Fed has remained committed to the 2 percent rate because the fixed target rate, and the monetary policy it fosters, helps assure markets and the public of the Fed's intent to induce price stability so that inflation is not a consideration in household and business spending decisions, a definition of price stability observed by former Fed chair Alan Greenspan.

For context, the inflation rate has remained above the Fed's 2 percent target since 2021, based on the Fed's preferred inflation measure, the personal consumption expenditures price index. The FOMC set the Fed funds target range at 3-1/2 to 3-3/4 percent at the March FOMC meeting.

The Fed formally adopted the inflation target of 2 percent inflation in January 2012 and has reaffirmed it every year since in the Statement on Longer-Run Goals and Monetary Policy Strategy. The FOMC's evolution toward greater transparency and accountability includes announcing after each policy-setting meeting the rate it intends to target, transparency measures, and accountability mechanisms. This approach is demonstrated in the FOMC's release after each policy-setting meeting of a statement, a note on monetary policy implementation, and the chair's meeting with reporters following the announcement of the materials.

Why the Fed sets a target inflation rate

The Fed had been contemplating a movement toward an explicit inflation target for years, since the first half of the 1990s, just as some other central banks around the world were considering the implementation of inflation targets. The institutions were in search of new monetary policy tools after determining that policies enacted in the decades following World War II did not accommodate changes in evolving economic and financial systems. The catalyst was the Great Inflation, an event in which inflation had risen from about 1 percent, in the late 1950s and early 1960s, to 14 percent in some advanced economies in 1984. This is the tail end of the era in which then Fed chair Paul Volcker faced down criticism, including the threat of impeachment by a Texas congressman, as the FOMC set the fed funds rate at 20 percent in late 1980 in an attempt to bring down inflation that had peaked at 11.6 percent earlier that year.

Some central banks made the concept of inflation targeting the cornerstone of their monetary framework policies. New Zealand adopted low inflation as monetary policy's sole medium-term objective, according to a report by the International Monetary Fund. That move occurred in 1989, after the country's Parliament fixed the economic target for monetary policy at a rate of zero to 2 percent. More than two dozen countries had adopted inflation targets by 2009, according to a report by the Bank of England. This year, the global inflation target for many major central banks is generally centered on a value of 2.3 percent, with 2 percent targets set by countries including China, the euro area, Japan, and the United Kingdom, according to a J.P.Morgan global inflation forecast released in February.

Meanwhile, as other central banks were embracing inflation targeting in the 1990s, the Federal Reserve was conducting its own research into the concept. In July 1996, Alan Greenspan, then the Fed chair, said the discussion of long-term inflation goals had been under way, "on and off for a long while, and I think we will continue to do so," according to minutes of the meeting. Greenspan named an array of issues involved in setting goals and strategies

In October 2003, Ben Bernanke, at the time a Fed governor and a future Fed chair, delivered remarks at a panel discussion at the St. Louis Fed in support of the concept of an inflation target that would be announced publicly, as well as a potential rate for the potential inflation target. For starters, Bernanke observed that price stability had been achieved in the United States, a posture that could change in the future as inflation moved too high or too low. Bernanke suggested the public would benefit from knowing the inflation rate that the Fed perceives as "just right." Bernanke further observed that "it may be the case that something in the vicinity of 2 percent is the optimal long-run average inflation rate for a variety of assumptions about the costs of inflation, the structure of the economy, the distribution of shocks, etc." Bernanke suggested additional research would be "highly worthwhile," and that having an estimate of the optimal long-run inflation rate "seems crucial to making good policy in the next few years."

Inflation target set at 2 percent

Nine years later, in January 2012, the Fed adopted the 2 percent goal with a broad base of support, according to minutes of the meeting. Bernanke, by this time the Fed chair, said after the vote, "I do believe this will be an important step for the FOMC and will help us improve our communication and our accountability going forward." Bernanke thanked then Fed governor Janet Yellen, the future Fed chair and Treasury secretary, who had chaired the subcommittee that drafted the document known as the consensus statement, known more formally as the Statement on Longer-Run Goals and Monetary Policy Strategy.

The intent was to create a durable document. Yellen said the consensus statement was "designed as an overarching set of principles that is intended to withstand the test of time," and that the subcommittee members "certainly hope that over the years and even decades to come, future Committee participants will also find these principles to be very reasonable and appropriate." Bernanke described the statement as "a sufficiently flexible document to allow for innovation as we move forward." Yellen noted the statement "necessarily involves some subtleties and nuances that will remain open to interpretation" as the principles are applied to monetary policy decisions.

This section of the consensus statement addressed the inflation target:

"Price stability is essential for a sound and stable economy and supports the well-being of all Americans. The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee can specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory maximum employment and price stability mandates. The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. The Committee is prepared to act forcefully to ensure that longer-term inflation expectations remain well anchored."