WHY IS THERE SUCH CONSENSUS ABOUT THE TWO PERCENT INFLATION RATE AMONG CENTRAL BANKS?`

Over the years, I have often wondered why every Central Bank seems to have a Target Rate for Inflation of two percent.   Rich country or poor, weak or robust economy, agriculturally-based or industrialized, East or West, it just doesn’t seem to matter!   Is there some universal factor, such as the speed of light, the boiling point of water or the number of hours in a day?  NO!  It appears, at least to me, that there is no rational reason whatsoever for the two-percent Inflation Rate other than, perhaps, that all of the various Central Banks wanted to be right or wrong–together.

There’s a cute little story of how this Target Rate all came about, 25 years ago in New Zealand, of all places.  OK, so you might not be somewhat of an Economics-Junkie, but I would still like to share it with you.  Now, when you consider some of the finest Economic Minds in Berlin, London, Tokyo and Washington all following the lead of little ole Wellington, doesn’t that peak your interest?  New Zealand, by the way has a population of 4.25 Million, and a GDP of just US$182.6 Billion.

It all started with kiwi farmer and banker, Don Brash.  He stepped down as Managing Director of the New Zealand Kiwifruit Authority, in order to become the Governor of the country’s Central Bank–the Reserve Bank of New Zealand.  Also, the nation’s economy had been quite stagnant throughout the 70s and 80s.

The Government charged the Finance Minister, David Caygill, and the Head of the Reserve Bank to establish a Target Rate for Inflation.  Eventually, they decided on two percent; however, there was considerable disagreement as to whether that rate was too high or too low.  Brash and Cargill had also wanted to firmly established the Independence of the Reserve Bank, to take it out of the Political Process.  

Now, I’m not making this up; but, when the proposal by Brash and Caygill came up for a vote in Parliament, one of its strongest opponents was laid-up in the hospital.  Parliament just brushed off the outside objections and passed the Proposed Target Rate.  Well you see, Christmas was just around the corner and they all wanted to go home.  So, the Two Percent Target Rate was passed and, in time, the economy stabilized.

Although there was little word of this action in the mainstream media, central bankers around-the-World certainly took notice.  The combination of slow Growth and high Inflation–called “Stagflation”–had been rampant throughout the Industrialized World at that time.  Canada adopted New Zealand’s Target Rate and, soon after, so did Sweden and Great Britain.  In fact, in Britain, the Governor of the Bank of England must write a letter to the Chancellor of the Exchequer (Finance Minister) whenever the Inflation Rate misses by more than one percent, in either direction.  Pretty serious stuff, huh?  Eventually, the Two Percent Target Rate was accepted by just about every Major Central Bank.

So, that’s how the Kiwis, according to a past NY Times article, in their far-off corner of the World, came to establish what has become one of the most Universal Economic Rules-of-Thumb!

 

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