Washington Examiner
· collected 2026-09-07 · by Davis D. Thompson
The Federal Reserve set 2% as its long-term inflation target in 2012.
asserted
Reserve → set → 2012
According to the St. Louis Fed website, the Fed believes “the economy can run efficiently when inflation is low and stable” and “people can hold money without having to worry that high inflation will erode its purchasing power.”
uncertain
inflation → accord → power
The insidious impact on retirees
The loss of 2% of a dollar’s purchasing power over one year does not seem significant.
asserted
loss → seem → year
However, consider a couple who retire at age 65 with a $1 million portfolio invested in long-term bonds yielding 5%.
asserted
who → consider → %
If they spend the $50,000 in interest each year, 2% inflation reduces the real purchasing power 45% to $27,500 in 30 years.
asserted
inflation → spend → years
People need to worry, big time.
asserted
People → need → ?
Recommended Stories
Most retirees have learned to estimate an initial amount to spend from their portfolio that can grow 2% annually without bankrupting them before they turn 95: $30,000 in this case.
asserted
they → learn → case
That seems truly insidious, but it’s very misleading.
asserted
it → seem → ?
With no long-term expected inflation, retirees should expect to earn 2% less on their portfolio because the nominal long-term bond yield generally reflects the real long-term interest rate plus long-term expected inflation.
asserted
yield → expect → rate
The effect of income taxes on inflation-caused ‘phantom’ income
Inflation causes additional income taxes on the additional $20,000 in “phantom” income caused by the inflation.
asserted
effect → cause → inflation
Assuming the retirees live in California and also receive $25,000 in Social Security ($75,000 total income), the additional taxes are about $3,700.
asserted
taxes → assume → Security
That means their spendable income from their portfolio has decreased about 12% from $30,000 to $26,300.
asserted
income → mean → 26,300
If they have some stocks in their portfolio, the decrease is less because dividends and capital gains are taxed more favorably.
asserted
dividends → have → portfolio
Using Vanguard’s asset allocation in its Retirement Income EFT Portfolio (VRIF) of 30% stocks and 70% bonds, the decrease is about 8% or $2,400.
asserted
decrease → use → stocks
The decrease in spendable income rises substantially as portfolio income increases, even with a 30% stock allocation: with $100,000 in portfolio income ($125,000 total income), it is about 10% or $6,000; with $225,000 ($250,000 total income), it is about 23% or $27,000.
asserted
it → rise → 225,000
In the United States, about two-thirds of households own their own home, but about 65% of those who do not own a home — roughly 28 million households — would like to.
asserted
who → own → home
About half of these households cannot afford the mortgage payment, and about 60% lack the down payment.
asserted
% → afford → payment
That means there may be up to 9 million households that might be able to buy a home if mortgage rates were substantially lower.
uncertain
rates → mean → home
Likewise, many of the 87 million homeowners who later buy a bigger home when they can afford the higher mortgage payments may have been able to buy that bigger home when they bought their first home, and could have avoided the costs of selling their first home and moving to a new home.
uncertain
they → buy → home
Over the last 25 years, the average fixed mortgage rate has been about 5.1%, and the average inflation rate has been about 2.6%.
asserted
rate → fix → years
That means that the real 30-year fixed mortgage rate has averaged about 2.5% (5.1%-2.6%).
asserted
rate → mean → %
That implies that the fixed mortgage rate with 2% expected inflation would be about 4.5%, and with no expected inflation would be about 2.5%.
asserted
rate → imply → inflation
For instance, a $500,000 mortgage would have monthly payments of about $2,000 instead of $2,500, $500 less.
asserted
mortgage → have → 2,000
The best solution is for the Fed to reduce its inflation target to zero or near zero, which is what the term “price stability” really means.
asserted
term → reduce → what
On the St. Louis Fed website, the Fed gives three primary reasons why it is better to target inflation at 2% rather than zero:
asserted
it → give → zero
Economists have estimates that the Consumer Price Index (“CPI”) overstates true inflation by 0.5% to 1.5%.
asserted
Index → overstate → %
However, the Personal Consumption Expenditures (“PCE”) index used by the Fed is estimated by economists to only have an upward bias of a few tenths of a percent.
asserted
index → use → percent
So, this reason only implies a need for about a 0.25% inflation target.
asserted
reason → imply → target
Room to cut interest rates: Because a higher inflation rate tends to cause a proportionally higher nominal interest rate, a 2% target gives the Fed more room to cut interest rates in the event of a recession to stimulate economic activity.
asserted
target → cut → activity
It is true that reducing rates by an additional 2% can help fight recession.
asserted
reducing → reduce → recession
However, doing so actually destabilizes interest rates, the price of borrowing money.
asserted
doing → do → money
Destabilized interest rates have very significant adverse effects on the economy, such as undesirable booms and busts in the housing market and the stock market.
asserted
rates → have → market
If reducing non-inflated interest rates to zero is not enough to fight off a recession, fiscal policy should be used.
asserted
policy → reduce → recession
In the last 100 years, the only significant deflationary period was during the Great Depression, partially caused by the Fed policy of maintaining significant nominal interest rates to prevent a run on gold.
asserted
period → cause → gold
In 1931, the third year of the depression, the Fed increased interest rates by 2% to stop a run on the U.S. gold reserves.
asserted
Fed → increase → reserves
As a result, real short-term interest rates were over 7% on average during the first four years of the Great Depression, compared to a 100-year average of around 2%, and by far the highest ever in the U.S. Today to combat potential deflation, the Fed would not hesitate to force short-term interest rates down to zero.
asserted
Fed → compare → zero
If that does not stop the deflation, then fiscal policy should be used.
asserted
policy → stop → deflation
Avoiding deflation seems like a minimal risk compared to the real problems caused by the 2% target.
asserted
Avoiding → avoid → target
The Fed’s goal, besides maximum sustainable employment, should be financial stability, which should include not only stable consumer and producer prices, but also stable interest rates.
asserted
which → include → prices
Furthermore, it should include asset prices of stocks and real estate that are not artificially affected by volatile interest rates caused by Fed policies.
asserted
that → include → policies
…and 1 more, not listed.
