The Fed's Inflation Target Is a Relic (And Everyone's Too Polite to Say It)

The 2% Target Nobody Can Explain

The Federal Reserve targets 2% inflation. Ask why, and you'll get vague answers about price stability and credibility. The real answer? New Zealand picked it first in 1989, and everyone else copied the homework.

That's not hyperbole. The 2% target emerged from a single country's experiment during a specific economic crisis, then spread globally because central bankers needed a number and 2% sounded reasonable. Thirty-five years later, we're still using it despite an economy that bears zero resemblance to 1989.

The problem isn't that 2% is wrong—it's that we've elevated it to sacred doctrine while the underlying assumptions have completely changed. When the Fed raises rates to hit this arbitrary target, they're optimizing for a metric that made sense when the Soviet Union still existed.

What Changed (Besides Everything)

The economy the Fed is trying to manage looks nothing like the one their models assume. Start with market concentration. The Magnificent Seven companies represent roughly 30% of S&P 500 market cap. These firms operate with different cost structures, pricing power, and response to monetary policy than traditional businesses.

When Apple or Microsoft adjusts prices, they're not responding to the same pressures as a regional manufacturer. Their margins are software-level, their moats are network effects, and their sensitivity to interest rates is mediated through stock buybacks rather than capital expenditure. Traditional monetary policy assumes firms are more or less similar. That assumption is dead.

Then there's the labor market. The Fed watches unemployment figures built for an industrial economy. Remote work, gig platforms, and the creator economy have created employment categories that don't fit the old buckets. Someone making $150k through a combination of contract work, content creation, and consulting shows up in statistics differently than someone with a traditional W-2—if they show up at all.

The Lag Problem Got Worse

Monetary policy works with an 18-24 month lag. That's the textbook answer, and it's probably still true. The issue is that economic conditions now flip in weeks, not quarters.

Look at March 2023. Silicon Valley Bank collapsed on a Friday. By Monday, the Fed had created a new lending facility. The speed of the crisis—driven by digital bank runs and social media panic—was orders of magnitude faster than policy transmission. The Fed was simultaneously fighting 2021's inflation while managing 2023's banking crisis while trying to predict 2024's economy.

This isn't a competence problem. It's a fundamental mismatch between policy speed and economic velocity. When information moves at internet speed but policy works at bureaucratic speed, you're always responding to the last crisis while the next one is already forming.

The Data Is Lying (Sort Of)

The Fed makes decisions based on data that's increasingly disconnected from reality. CPI measures a basket of goods that doesn't reflect how people actually spend money. Housing costs use "owner's equivalent rent"—a fictional number based on what homeowners think they could rent their house for.

Meanwhile, the things that actually matter to quality of life—healthcare, education, childcare—have inflated far beyond the headline numbers, while technology has deflated to near-zero marginal cost. The average is meaningless when the distribution is bimodal.

Employment data comes with revisions that can swing by hundreds of thousands of jobs. The Fed is making rate decisions based on numbers that will be revised months later. It's like steering a ship using a map that gets updated after you've already hit the rocks.

What Happens When the Model Breaks

The Fed's models assume a stable relationship between unemployment and inflation—the Phillips Curve. That relationship has been unstable for years. We've had low unemployment with low inflation, high inflation with low unemployment, and everything in between.

When the model stops working, you have two choices: update the model or pretend it still works while making ad hoc adjustments. The Fed has chosen option two. They talk about the Phillips Curve in testimonies while making decisions that suggest they know it's broken.

This creates a credibility problem. Markets are trying to predict Fed actions, but the Fed is using models they don't fully believe while claiming certainty they don't have. The result is volatility driven by interpretation of Fed-speak rather than actual economic conditions.

The Honest Answer Nobody Wants

Here's what the Fed should say but won't: "We're doing our best with imperfect tools to manage an economy we don't fully understand, using models built for different conditions, with data that's often wrong, and policy that works too slowly."

That's not incompetence—it's honesty. The economy is too complex, too fast-moving, and too different from historical patterns for anyone to manage with precision. Central banking worked better when economies were simpler and slower.

The alternative to admitting this is what we have now: confident pronouncements based on questionable models, followed by surprised reactions when things don't work as predicted, followed by explanations about "transitory" factors that turn out to be permanent.

What Comes Next

The Fed will probably keep targeting 2% inflation because changing it would require admitting the current framework is arbitrary. They'll keep using models they know are broken because the alternative is admitting they're flying blind.

Markets will keep trying to predict Fed actions by parsing every word of every speech, looking for signals that the Fed itself isn't sure about. We'll get more volatility, more surprises, and more post-hoc explanations.

The real question isn't whether the Fed will change its approach—it's whether the economy will change faster than the Fed can adapt. Based on the last few years, the economy is winning that race.

Maybe the best monetary policy is admitting when you don't know. The Fed won't do that, so we're stuck with confident predictions about an unpredictable system, made by people using tools designed for a different era. It's working about as well as you'd expect.