Mr. Powell Says the Good Times Are Coming!
Chakravarthy V
2M Impressions | Co-Founder at Prime Wealth Finserv. Helping High Net Worth Individuals with their Investment Needs QPFP®️ Qualified Personal Finance Professional®️ CWM®️ from American Academy of Financial Management
Hello readers!
“2%.”
It looks like just a random number. But for the past three decades, this tiny figure has been one of the most powerful digits in global finance. Why? Because that’s the inflation rate the Federal Reserve — the most influential central bank in the world — wants to see in the US economy.
Why 2%?
Honestly, there’s nothing magical about it. Back in the early 1990s, New Zealand was trying to bring down inflation. They picked 2% as a nice, believable target — not too high, not too low. It worked. Soon, other central banks copied it. By 2012, the US Federal Reserve made it official. Economists liked it because it avoided the dangers of deflation, but it also wasn’t so high that people would notice prices rising too fast.
So yes, 2% was more of a practical guess than a scientific law. But once the world accepted it, that number started moving markets everywhere.
Why It Matters So Much
When US inflation rises above 2%, the Fed usually raises interest rates. That makes the US dollar stronger. And when the dollar strengthens, money often leaves emerging markets (like India) and flows back into the US. Asset prices swing, debt becomes more expensive, and currencies like the rupee feel the heat.
If inflation falls below 2%, the opposite happens. So, in a way, that tiny number decides whether billions of dollars enter India or leave it.
The Fed’s Struggle With 2%
Here’s the funny part — the Fed hasn’t been able to keep inflation at 2% for quite some time. In the 2010s, inflation was too low. After COVID, it was way too high — the highest in 40 years.
In 2021, the Fed tried something new called Flexible Average Inflation Targeting (FAIT). The idea was simple: if inflation had been below 2% for a while, the Fed would allow it to go above 2% for some time to “balance things out.”
Sounds reasonable, right? But reality didn’t play along. Inflation didn’t just cross 2%. It shot up to around 8%! Instead of carefully balancing the system, FAIT looked like adding fuel to the fire.
The Recent Shift
Fast forward to this month. The Fed quietly changed its wording around the 2% target. Earlier, it was okay with inflation staying above 2% for a while. Now, the Fed has said it will act to ensure that long-term inflation expectations remain “anchored.”
In plain English, this means the Fed no longer wants to “forgive” higher inflation by averaging it out. It still respects the 2% target, but it is treating it with more flexibility.
So What Does This Mean?
At first glance, this might feel like a small wording change. But in central banking, words matter a lot. They signal future actions.
Now, the Fed may not keep interest rates very high until inflation is exactly at 2%. For example, if inflation is 2.6% but falling, and if the US job market looks weak, the Fed could still cut rates. Jerome Powell, the Fed chair, has already hinted that the “neutral rate” — the sweet spot where policy is neither too tight nor too loose — may be higher than before.
So in practice, the Fed is giving itself more room to cut rates without waiting for inflation to be perfectly under control.
Why Credibility Matters
The truth is, everyone knows that 2% is arbitrary. The real importance lies in psychology. As long as people believe inflation will stay near 2%, wages and prices remain stable. But if people lose that belief, inflation expectations can spiral. That’s why Powell keeps repeating the Fed’s loyalty to the 2% target, even while bending the rules quietly.
What It Means for Markets
This shift changes the whole picture. Many people had been expecting a market crash, thinking the Fed would keep tightening until inflation hit exactly 2%. But if the Fed is now willing to cut rates earlier, the downturn may not be as harsh.
And there’s another factor: US government debt, which now stands at around $34 trillion. Every 1% increase in interest rates adds hundreds of billions of dollars to the US government’s interest bill. So cutting rates before inflation reaches exactly 2% is also a way of managing this massive debt.
In simple terms, the Fed could lower rates while asset prices are still high. That puts more money into the system, and history shows liquidity often pushes stock prices, bond prices, and other assets higher before any correction arrives.
Why India Should Care
This isn’t just about the US. When the Fed loosens policy, foreign investors often pour money into Indian markets. That pushes valuations up, supports the rupee, and gives exporters like IT and pharma companies a boost when the US economy stays strong.
The Reserve Bank of India (RBI) also watches these signals closely. With its own inflation target of 4%, it learns from the Fed’s playbook while balancing India’s domestic needs.
The Bigger Picture
The bottom line is simple: 2% still stands as the Fed’s official target, but the way it interprets it has become more flexible. The central bank is now balancing inflation with growth, jobs, and debt. And for investors, the bigger surprise may not be a sudden crash, but the possibility of this cycle stretching longer with liquidity fuelling markets.
Central banks rarely change their words by accident. If you pay attention to the edits, you get clues about the future. That small shift from “average” to plain “inflation targeting” could end up shaping the next phase of global markets.
📅 Coming up next week!
September 1 (Monday)
September 2 (Tuesday)
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September 5 (Friday)
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Chakrivardhan Kuppala, Cofounder & Executive Director, wrote for Moneycontrol:
Chakravarthy V wrote for The Economic Times:
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