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No one wants their costs to go up.

And yet one of the most relevant numbers in modern economics — and plenty of recent headlines — is the Federal Reserve's goal of a 2% annual inflation rate. This begs the question: Why isn't the goal 0% inflation? Doesn't everyone want to keep life from getting any more expensive?

The thing is, although we'd all love to avoid any more price increases, targeting 0% inflation leaves zero margin for error. A low, predictable rate of inflation shields the economy from the risk that prices will fall, according to economists. It's counterintuitive, but a sustained decline in prices — known as deflation — tends to actually weaken an economy.

Think about it: If you expected prices to get lower and lower, you'd probably wait as long as possible to buy stuff. That, in turn, would hurt company revenues, leading to lower wages and higher unemployment. It would also make any money you'd borrowed before more expensive to repay.

In other words, the Fed targets 2% to have a buffer and ensure there's always some grease for the economy's wheels.

So what?

The weird thing about inflation is that it can become self-reinforcing. Inflation stems from an imbalance in supply and demand (created by either a spike in demand or a shortage of supply,) but people's expectations of prices also play a big role.

If people and businesses think prices will keep rising, they make decisions around that expectation. To capitalize, companies may raise prices, workers may expect higher wages, and consumers might rush to buy big-ticket items before they get more expensive. All this keeps demand and prices moving higher.

But if the Fed commits to a consistent rate of inflation, everyone knows what to expect. Families can make longer-term decisions about spending and saving, and businesses can plan for hirings, expansion, and investments. This predictability, says the Fed, is why the 2% inflation target is so critical.

In reality, inflation has remained closer to double the Fed's target for much of 2026, according to the Fed's preferred inflation measure.

After cooling to under 3% the previous two years (the pandemic peak was 7.2%), this year's surge in oil prices has driven up costs for everyday staples like gas and groceries. As of July, inflation sat at 3.7%, according to the latest data available.

That's why the Fed just raised benchmark interest rates for the first time in more than three years — and suggested rates would continue to go up.

Think of interest rates like an economic thermostat that the Fed dials up and down to control inflation. When it becomes more expensive to borrow money, it's harder for people and companies to afford things, so demand shrinks.

But it's a delicate balancing act, since the Fed doesn't want to slow the economy too much. Then inflation would be tamed, but we'd likely see a spike in unemployment.

Related Reading

How to Beat Inflation: 6 Strategies to Consider (SoFi)

Fed Again Hoping for a Pain-Free Landing from Current Inflation Spike (Reuters via Yahoo Finance)

Why the 2% Inflation Target? (Michigan Journal Of Economics)

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