The 2% inflation target in the news every day was not determined by super computers or artificial intelligence it all began in New Zealand in 1989. The New Zealand government wanted to codify the independence of its central bank, so they passed legislation that required the Head of the Central Bank to establish a target inflation rate. The law also said not hitting the target was grounds to be fired. The Central Bank then announced the target rate would be 2%- it was a number that felt appropriate but not based on mathematical calculations. This triggered other countries including the US to start thinking about setting a target.

In the US, Alan Greenspan thought the target should be between 0% and 1%. Janet Yellen (yes, the same Janet Yellen) argued for a higher return saying that going into a recession with low inflation could lead to deflation. From 2000 to 2007 the target rate was increased to 1.5% and after the Great Financial Crisis, Ben Bernanke codified the 2% target that we have today.

“In a healthy economy, prices tend to go up- a process called inflation”
Professor Richard Warr

In a healthy growing economy, the demand for goods and services increases which drives prices higher and creates demand for more labor which increases wages. With higher wages and employment, the demand continues to rise in a virtuous upward direction- inflation is good! However, too much of a good thing can lead to stagflation where unemployment increases, and inflation moves higher. The FED is trying to maintain this delicate healthy balance.

The opposite of inflation is deflation and economists consider this much worse than inflation. The US suffered deflation of 7% a year during the first 3 years of the Great Depression. With deflation the value of money increases if you do nothing because prices are falling, and your dollar will go farther the longer you wait. In this scenario the velocity of money decreases, investing slows, GDP falls, and unemployment follows. Japan in the 1990s suffered a deflationary cycle that led to decades of stagnation. China today is facing a similar challenge.

In multi-family inflation is a good thing because we have fixed debt and rising income which creates value over time. We will need to see inflation in control before meaningful rate cuts are implemented. The only question is how much damage “will higher rates for longer” do to commercial real estate and businesses in the US and will it lead to a recession. We are monitoring this situation very closely.