2% vs 3%, should the Federal Reserve raise its inflation target? Analysts say this would "invite trouble"

According to Dolphin Research, the US Federal Reserve raised its benchmark interest rate to a target range of 5.25% to 5.5% last month, the highest level in 22 years. The focus of market debate has now shifted from how "high" the interest rate should be to how "long" it should be maintained. In addition, there have been different opinions on the 2% official inflation target set by the Federal Reserve, with many economists suggesting a target of around 3% would be acceptable.

A media survey conducted from August 11th to 16th of 68 economists revealed that forecasters expect the central bank to hold off on interest rate cuts until the second quarter of next year, three months later than the forecast in July.

On Tuesday, Thomas Barkin, President of the Richmond Federal Reserve Bank, said, "2% is not a number we can never achieve." If the Federal Reserve were to consider changing this target before achieving the 2% inflation goal, it could lose credibility. Barkin will not vote on monetary policy decisions this year and did not comment on the timing of rate cuts. He stated that possible criteria for allowing rate cuts include observing a gradual cooling of inflation over time and observing stable demand.

The Federal Reserve's preferred inflation gauge, the Personal Consumption Expenditures Index, rose 3% year-on-year in June, the smallest increase in over two years. This is a decrease from last year's 7%, when the Federal Reserve launched its most aggressive policy tightening action in a generation.

Prominent economists are calling for central banks, including the Federal Reserve, to consider raising their targets. Olivier Blanchard, former Chief Economist of the International Monetary Fund and current researcher at the Peterson Institute for International Economics, said last year that when the inflation rate falls to 3%, central banks should stop tightening policies and make it a new target. Jason Furman, a professor at Harvard University and former Chairman of the Council of Economic Advisers, called on the Federal Reserve in a commentary article published last weekend to "start shifting from hawks to higher inflation targets."

Torsten Slok, an analyst at investment management company Apollo, said that speculation about the Federal Reserve raising its inflation target has brought new risk premiums to long-term interest rates. There are many factors keeping yields high, including a large amount of short-term US government bonds that need to be rolled over into longer-term bonds due to the recent debt ceiling impasse. Rolling over will increase the supply of longer-term bonds and put upward pressure on yields. "In this situation, I'm not sure changing the inflation target is a good idea."

On Tuesday, Barkin reiterated his speeches on August 3rd and 8th, stating that the slowdown in inflation in June was better than expected, which may indicate that the US economy can achieve a "soft landing" and restore price stability without a destructive recession. Barkin mentioned that even in the event of a recession, the severity of the economic downturn would be mitigated due to strong demand for frontline workers, reduced labor force attrition, potential demand for goods with limited supply such as automobiles, and conservative inventory management measures by businesses.