My professional focus has been identifying and trying to correct the common behavioral errors we all make as investors.
One cannot help but notice how similar mistakes are made by these large collections of people operating within large organizations. It is a side effect of observing markets and the economy: giant institutions making errors. The Federal Reserve, Treasury, Congress, corporations, and other institutions can – and too often do – engage in the same behavioral mistakes we see individuals make. After all, large institutions are essentially a collection of individuals in a hierarchical structure, acting on behalf of their owners, patrons, and constituents.
The difference between individual errors and institutional ones is in magnitude. When Congress screws up, we may get a financial crisis; when the Fed makes a big mistake, unemployment may rise, or inflation may get out of control. The stakes for institutional errors are so much greater than the regular snafus each of us falls prey to.
Today was Fed Chair Kevin Warsh’s first speech as chair at Jackson Hole. The line that stood out to me was not his discussion of AI, but rather, “The Fed should be humble and never naïve.”
I, too, would like to see a more humble Fed. I’d like to see less certainty in their beliefs, fewer forecasts, reduced reliance on surveys and inflation expectations, and even less reliance on their belief that they are the dominant player impacting prices. And I’d like to see a greater acknowledgment that their models, while often useful, are also wrong.
Worse, we see little evidence of that humility in the Fed’s 2% inflation target: “The Fed’s price-stability objective of 2 percent, as measured by the personal consumption expenditures (PCE) price index, is a firm, fixed target.”
I have discussed this before, but rather than repeat those complaints, let’s consider the target from the perspective of institutional error and correction.
–2% Inflation Target History: As former Fed Vice Chair Roger Ferguson explained, it is an anomaly that traces back to an offhand political remark by Finance Minister Roger Douglas on New Zealand television in March 1988, in which he said he wanted inflation brought down to “around 0 to 1 percent.”
Thus, the 0–2% band was born and codified by the Reserve Bank Act of 1989. It was adopted by Canada in 1991, the UK in 1992, Sweden, Australia, and Finland in 1993, the ECB in 1998, and, finally, by the Fed at the July 1996 FOMC meeting.1 On January 25, 2012, then Fed Chair Bernanke made it official.
–Evidence for 2% is non-existent: Little in the academic literature suggests the 2% inflation target is anything other than an arbitrary number. 2 I will spare you the tedious exercise of reviewing a spate of papers, and instead point you to a survey of 600 economists: more than half would keep the current 2% target, citing the “credibility cost” of changing the target – not what target number is optimal. 3
This is classic institutional behavior: refusing to correct an error for reputational or credibility reasons is simply ego over substance.
– The Post-Pandemic Regime: The largest U.S. pandemic in over a century was followed by the biggest post-World War II fiscal stimulus. This changed everything: It scrambled supply chains, shifted consumption habits, and upended inflation. In light of massive regime change, one might imagine the Federal Reserve would adapt to the new conditions.
Yet they have failed to do so…
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All good traders know that their cheapest mistake is their first one — and it should be unwound immediately. Doubling down, refusing to fix a bad trade, failing to acknowledge that conditions have changed — these are recipes for expensive failures.
The 2% inflation target is an accidental anomaly, a political improvisation from New Zealand circa 1988. Hardening it into monetary policy orthodoxy is a classic form of institutional error. The sooner the mistake is unwound, the better off the global economy will be.
We all suffer from cognitive judgment errors. It is an unavoidable aspect of the human condition. If we can better understand how and why these errors occur, we have a fighting chance to correct them. It would be enormously productive for society if our largest, most influential, and most important institutions could do the same.
Previously:
2% Inflation Target is Silly (July 26, 2023)
3% Is the New 2%… (August 3, 2026)
What’s Upsetting the Bond Market? (August 25, 2026)
Five Ways the Fed’s Deflation Playbook Could Be Improved (Businessweek, August 18, 2023)
What Models Don’t Know (May 6, 2020)
Source:
In Our Time Chairman
By Kevin Warsh
Fedewral Reserve, August 28, 2026
__________
1. Greenspan insisted the number stay secret: “If the 2 percent inflation figure gets out of this room, it is going to create more problems for us than I think any of you might anticipate.”
2. Claude tells me the following: “No paper derives 2% as the optimal inflation rate. The number preceded the research, and the literature since points in every direction.”
The specific examples include The Boskin Commission, Akerlof, Dickens & Perry (1996), Blanchard, Dell’Ariccia & Mauro (IMF, 2010), Ball (2014).
3. See “The optimal inflation target: Views from 600 economists,” by Kim Ristolainen, Andrea Ferrero, Esa Jokivuolle, Gene Ambrocio, 21 Jul 2022.
