The 2% target: why that number?
In the late 1980s and early 1990s, New Zealand pioneered the idea of giving central banks an explicit numerical inflation target. Most major economies adopted variants of this by the 2000s. The near-universal choice of 2% wasn't the result of precise economic modelling — it was chosen as low enough to preserve the value of money, but high enough to provide a buffer against deflation (which is extremely hard to escape). It also implicitly allows for the fact that inflation measures overstate true price increases slightly.
Why expectations matter so much
Inflation is partly self-fulfilling. If workers expect 8% inflation next year, they'll demand 8% wage rises. If companies expect 8% inflation, they'll raise prices by 8% to maintain margins. Both actions cause exactly the inflation that was expected — a vicious cycle. The genius of a credible inflation target is that it breaks this cycle before it starts: if everyone believes inflation will stay at 2%, they act as if it will, and it does.
Which central banks target inflation?
| Central bank | Target | Adopted |
|---|---|---|
| Reserve Bank of New Zealand | 1–3% | 1990 (first) |
| Bank of England | 2% CPI | 1997 |
| European Central Bank | ~2% | 1999 |
| Federal Reserve | 2% PCE (average) | 2012 (formal) |
When targeting fails: the 2021–23 inflation surge
Credibility is not permanent. When Covid-era supply disruptions and fiscal stimulus pushed inflation to 8–11% across developed markets — and central banks initially called it "transitory" — they risked losing their hard-won inflation-fighting credibility. The aggressive rate-hiking cycle of 2022–23 (the sharpest in 40 years) was partly about restoring that credibility, not just mechanically controlling prices.
"Credibility is won over decades and lost in months. Once inflation expectations become unanchored, the cost of re-anchoring them is enormous." — a central banking truism
What this means for you
When central banks publish inflation forecasts and meet to set rates, they are partly trying to manage what you and I expect prices to do. If you follow these announcements, pay attention not just to the rate decision but to the language around the inflation outlook. "Inflation is on track to return to target" is the most reassuring sentence a central banker can say — markets move on these words as much as on the numbers themselves.