- [Narrator] For the Federal Reserve, controlling inflation

is a little like playing a game of darts,

just scored differently.

It uses its tools to aim

for that bullseye, which in this case is.

- 2%.

- 2% inflation target. - 2% target.

- [Narrator] And just like with darts,

the Fed doesn't always hit the center.

- The process of getting inflation back down

to 2% has a long way to go.

- [Narrator] But even getting close

can help keep inflation in check.

Here's how 2% became the Fed's bullseye

and why that number can help guide the health

of the entire economy.

So where did the Fed come up

with this target in the first place?

The answer, New Zealand.

Suffering from persistent inflation in the 1980s,

the country's reserve bank initially set an inflation target

between 0 and 2%.

- Central banks didn't use to tell people

what they were doing, and in the 1990s,

they began to experiment more with, "Hey,

if we tell people what it is we're actually trying to do,

then maybe it'll make it easier

for us to achieve those goals."

- [Narrator] It's a strategy called anchoring.

When consumers and businesses know

where inflation should run,

it's easier for them to set prices

and spend in a way that's consistent with that goal

and that then helps the Fed set policies

to maintain that level of inflation.

Think of it as the bullseye

at the center of the Fed's monetary policy.

- If you think prices are gonna be higher in a year,

you'll demand higher wages now.

So there can be a self-fulfilling element

to inflation expectations.

- [Narrator] Though targeting has been

in the Fed's conversation for decades,

the US only officially adopted inflation targeting

in 2012 when the Fed was chaired by Ben Bernanke.

- Clearly communicating to the public this 2% goal

for inflation over the longer run

should help foster price stability

and moderate long-term interest rates,

and will enhance the committee's ability

to promote maximum employment

in the face of significant economic disturbances.

- [Narrator] So what's so special about the number two?

- There isn't a lot of empirical research

that says we've analyzed all the different outcomes

and 2% is the right number for these reasons.

That's really not how central bankers came up with 2%.

The idea was you wanted to have a a level of inflation

that was low enough that people wouldn't pay attention

to how high prices were going up.

- [Narrator] For the Fed,

the number two achieves a few things.

For starters, it's not so low

that the economy risks deflation, which is when prices fall

and can lead to lower wages and higher unemployment.

The economy was at risk for deflation

during the Great Recession between 2007 and 2009.

- Falling prices for a central bank can actually

be a worse state of affairs than rising prices

because if people think prices are gonna be lower tomorrow,

they won't spend today

and that can be very hard to get out of.

- [Narrator] Lower inflation also reduces the Fed's ability

to lower interest rates

because rates tend to move together with inflation.

- If you have a 0% target,

you'll probably have lower interest rates

and the concern would be you'd have less room

to stimulate the economy when you go into a recession.

- [Narrator] But 2% is also thought of as not too high.

High inflation can weaken consumers' spending power.

- The concern would be

that inflation might actually creep too high

and then you'd get into a world

of self-sustaining price increases

where higher prices feed on themselves

and that's a cycle the Fed doesn't wanna find itself in.

- [Narrator] The Fed wants inflation to hit as close

to 2% as it can over time to maintain a healthy economy.

But sometimes it misses.

Through the 2010s, some economists were concerned

that inflation was consistently running too low.

A new policy in 2020 called

flexible average inflation targeting tries

to account for some of those periods.

Rather than always aiming for the bullseye,

the Fed tries to set policy to balance out periods

of lower inflation with periods of slightly higher inflation

with the goal of averaging out at 2% over time.

- The worry was that the anchor

on inflation expectations was actually drifting too low.

And so you could recenter it by saying, look,

we really wanna make sure people don't think 2%

is a hard ceiling.

It's a target.

If we're below it for a little while,

we can be above it somewhat for a little while.

- [Narrator] But not everyone agrees

with the Fed's 2% target strategy.

One concern is that monetary policy is imprecise.

- You know, monetary policy's a blunt instrument.

This is more

like going to see a barber than having a surgery.

- [Narrator] Some also argue that a higher rate of inflation

leaves more room for the Fed to adjust interest rates

to avoid a recession.

Whether or not inflation targeting is actually effective

is difficult to measure.

Inflation did settle for a time after the policy

was implemented in New Zealand in the '90s

in conjunction with a number of other measures,

and it's still relatively new in the US.

- As we've discovered,

there are shocks that can hit the economy

and it's difficult to judge in real time I think

whether this is the right strategy.

- Currently, the Fed reviews the framework

of its monetary policy every five years.

- The idea that the Fed would make some kind of change

to its inflation target in the next couple of years seems

like a big stretch, but they could debate at the margins,

are there different nuances

that our formal strategy document hasn't captured?

And those are the sorts of things

that you might expect to see in the deliberations

around any further review of the framework.

- [Narrator] But for now.

- 2%.

- [Narrator] Remains the bullseye it will keep aiming for.

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