Why does the Federal Reserve aim for 2 percent inflation over time?
Low and stable inflation helps the economy operate efficiently. The Federal Open Market Committee (FOMC) judges that an annual increase in inflation of 2 percent is most consistent over the longer run with the Federal Reserve's mandate for price stability and maximum employment.
When inflation is low and stable, individuals can hold money without having to worry that high inflation will rapidly erode their purchasing power. Moreover, households and businesses can make more accurate longer-run financial decisions about borrowing and lending and about saving and investment. Longer-term interest rates are also more likely to be moderate when inflation is low and stable.
Over time, a higher inflation rate would reduce the public's ability to make accurate longer-term economic and financial decisions. However, a lower inflation rate would be associated with an elevated probability of falling into deflation, which means prices and perhaps wages, on average, are falling—a phenomenon associated with very weak economic conditions. Having at least a small level of inflation makes it less likely that the economy will experience harmful deflation if economic conditions weaken. The FOMC implements monetary policy to help maintain an inflation rate of 2 percent over the medium term.
The inflation rate is measured by the annual change in the price index for personal consumption expenditures, an important price measure for consumer spending on goods and services.