Why Does the Fed Target 2% Inflation? The Record Since 2012

In January 2012, the Federal Reserve wrote down a formal goal for inflation: 2% a year. In August 2026, prices on the measure it targets were 3.4% higher than a year earlier. Inflation on that measure has now been above 2% for 66 months in a row.

Why 2%? Why not 0% or 4%? Here is what the target is, where it came from, the reasons for the number and the Fed's record against it.

The target is written in the Fed's Statement on Longer-Run Goals and Monetary Policy Strategy. The statement names the measure: "the annual change in the price index for personal consumption expenditures". It calls 2% on that measure "most consistent over the longer run" with the Fed's mandate from Congress.

Congress gives the Fed two goals: maximum employment and stable prices. This is called the dual mandate. Congress sets no number for either. We cover it in What Does the Fed Do?

New Zealand went first. In March 1990, its central bank was given a target of 0% to 2% inflation, to be reached by December 1992. The Fed followed in January 2012, under Chair Ben Bernanke.

Source: Reserve Bank of New Zealand; Federal Reserve

The 2020 change followed years of low inflation. From 2012 to 2019, before the pandemic, headline PCE inflation averaged 1.4% a year. So the Fed said that after such periods it would aim for inflation "moderately above 2 percent for some time". The aim, called flexible average inflation targeting, was an average of 2% over time.

The 2025 review reversed that part. In August 2025, Chair Jerome Powell said the Fed had "eliminated the 'makeup' strategy". It returned to aiming for 2%, without making up past misses.

The St. Louis Fed gives three reasons for a goal above zero.

Price indexes overstate inflation. Better products and switches to cheaper goods are hard to price. In 1996, a US Senate commission led by economist Michael Boskin looked at this. It found that the Consumer Price Index (CPI), the other main US price measure, overstated inflation by 1.1 percentage points a year. In 2018, economist Brent Moulton put it at about 0.85 percentage points for the CPI and about 0.5 for the PCE Price Index. So measured inflation of 0% could mean prices were really falling.

Room to cut interest rates. The Fed's main tool is a target range for the Fed Funds Rate, which banks charge each other for overnight loans. Interest rates include expected inflation, so a lower inflation goal means lower rates in normal times. Economists at the IMF made this point in 2010.

Recessions have needed big cuts. From 2001 to 2003, the Fed cut its target by 5.5 percentage points. In 2007 and 2008, it cut by 5 percentage points, to almost zero. The IMF economists estimated the US needed 3 to 5 percentage points more, which it could not make.

In September 2026, Fed officials put the long-run Fed Funds Rate at 3.2%, with inflation at 2%. By our own sum, that is a real rate, after inflation, of about 1.2%. With a 0% goal, that 1.2% would be all the room there is to cut.

Wages are hard to cut. A 2016 Fed staff study found that US employers resist pay cuts in dollars, even in the 2008–09 recession. With some inflation, pay can lose buying power without a cut in dollars. In 1996, economists George Akerlof, William Dickens and George Perry put a cost on zero. Moving from 3% inflation to zero, they estimated, would raise the lowest sustainable Unemployment Rate by 1 to 2 percentage points.

In February 2010, IMF chief economist Olivier Blanchard and two colleagues asked whether central banks should aim higher. Are the costs of inflation "much higher at, say, 4 percent than at 2 percent"? A 4% goal would mean rates about 2 percentage points higher in normal times, giving more room to cut.

The same note named the costs. Inflation expectations, the inflation households and firms expect, may be harder to anchor at 4%. Anchored means they stay near the goal when prices jump. Higher inflation could also spread wage indexation, where pay rises automatically with prices. That would make inflation shocks bigger.

The Fed kept 2%. In December 2022, Powell said: "We're going to keep our inflation target at 2 percent."

So the reasons set a floor and a ceiling. 2% sits above the bias of about 0.5 percentage points in the PCE Price Index. It also stays well short of 4%, where the IMF note named the costs.

The chart shows headline PCE inflation each month. Over the 176 months to August 2026, inflation was above 2% in 78 of them, or 44%.

This chart shows the level of prices, with January 2012 set to 100. The dashed line shows where prices would be after rising exactly 2% a year. That path is our own yardstick, not a Fed target.

In August 2020, when the Fed adopted flexible average inflation targeting, prices were 5.8% below the path. The surge from 2021 closed that gap by May 2022. By August 2026, prices were 5.0% above it. Over the whole period, prices rose by 2.3% a year on average.

The Fed targets 2% because it is low enough to count as stable prices, while leaving a margin for measurement bias, rate cuts and pay that rarely falls in dollars. It also stays short of 4%. Since 2012, inflation on its chosen measure has run below that goal and then above it.

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