The origin of 2% inflation target 

The 2% inflation target is the global benchmark for price stability. It acts as a “Goldilocks” number: high enough to keep the economy from freezing up into a depression, but low enough that everyday consumers and businesses do not have to worry about rapidly rising costs. https://www.cavendish.ac/the-2-inflation-target-is-an-ad-hoc-and-an-arbitrary-choice/

Origin of the 2% Figure

The 2% target was not born out of rigorous academic research, but rather a casual remark during a 1988 television interview in New Zealand.

• The Inventor: New Zealand’s Finance Minister, Roger Douglas, offhandedly stated that he wanted inflation brought down to “around 0 or 0 to 1 percent.”.
• The Policy Implementation: Taking the cue, Arthur Grimes and other economists at the Reserve Bank of New Zealand formalised a target band. They added a small buffer for measurement errors, creating a 0% to 2% target range in the 1989 Reserve Bank Act.
• Going Global: Because New Zealand successfully crushed its double-digit inflation using this method, other major central banks quickly adopted the 2% standard. The ?Bank of Canada followed next, followed by the ?Bank of England, the ?European Central Bank, and finally the US ?Federal Reserve under Ben Bernanke in 2012.

Why Not 0% Inflation?

While 0% inflation sounds perfect on paper, central bankers heavily resist it for several structural reasons:

• Preventing Deflation: If inflation drops to 0%, a minor economic shock can push it into negative territory (deflation). Deflation causes a toxic economic spiral: consumers delay buying things because they expect goods to get cheaper tomorrow, which destroys business revenue and triggers mass layoffs.
• Greasing Labor Market Wheels: When businesses face financial downturns, they rarely cut workers’ nominal wages because it destroys employee morale. A 2% inflation rate allows businesses to keep wages flat, which naturally reduces their “real” labor costs over time without having to resort to mass firings.
• Providing Room to Cut Interest Rates: Central banks lower interest rates to boost the economy during a recession. Since nominal interest rates naturally track alongside inflation rates, a 2% inflation environment ensures baseline interest rates sit comfortably above zero. If inflation were 0%, central banks would immediately hit the Zero Lower Bound (ZLB), leaving them powerless to cut rates during crashes.

Why Not 3% (or Higher)?

Some prominent economists argue that central banks should raise the target to 3% or 4% to give themselves more interest-rate cutting power during recessions. However, institutional policymakers reject this change for two key reasons:

• Eroding Public Credibility: Changing the target from 2% to 3% simply because it gets hard to hit would damage the credibility of central banks. Markets and the public might suspect that if the bank struggles to contain 3% inflation, they will simply move the goalposts to 4% or 5% next time.
• Violating “Price Stability”: At 2% inflation, prices double every 35 years—low enough that people can generally ignore it when making long-term financial plans. At 4% inflation, prices double every 18 years. This faster compounding rate forces businesses and households to constantly recalculate contract agreements, eroding purchasing power too quickly.

But there was no proper research done on setting this rate and it was political choice taken by New Zealand government to tackle their high inflation at a time considering that their economy both in size and complexity did not reflect the rest of big developed economy following them dose appear an ad hoc decision rather than a scientific one. For more read my next article: “The 2% inflation target is an ad hoc and an arbitrary choice”