Is the 2 Percent Inflation Target Sufficient? The Wealth Preference Approach

We construct a macroeconomic model based on household wealth preferences to identify the theoretical conditions under which full-employment and/or stagnation steady states hold. The theoretical conditions also specify the minimum level of inflation target that shifts the economy from stagnation to full employment. Applying these conditions to Japanese and US data, we assess whether both economies have experienced stagnation in recent decades. Our findings suggest that both steady states are feasible in Japan, while only the full-employment steady state holds in the US. If Japan were to transition to full employment solely through monetary expansion, the inflation target would need to be 5% or higher, with an immediate and significant price increase unavoidable. Moreover, even if a 5 percent inflation target had been implemented in the late 1990s, it would have led to a welfare loss owing to the substantial reduction in the real value of financial assets caused by the initial price surge and subsequent inflation, which outweigh welfare gains from consumption.