Warren Buffett Wants the Fed to Target Zero Inflation—Here's Why Economists Say That's Risky

Warren Buffett thinks the Federal Reserve is too comfortable with rising prices, even if it reaches its stated goal of limiting inflation to 2% a year.

At 2% annual inflation, a dollar loses almost half its purchasing power over 30 years. Buffett, the legendary investor who recently handed over the reins at conglomerate Berkshire Hathaway, is at odds with central bankers and most economists, who say that permanently lowering inflation to below 2% would do more harm than good.

"I wish they had a zero inflation target," Buffett told CNBC on March 31 in his first extended interview since stepping down as Berkshire's (BRK.A, BRK.B) CEO. "Once you start saying you're going to tolerate 2%, that compounds pretty dramatically over time."

The 2% inflation target traces back to an offhand remark by a New Zealand finance minister in a 1989 TV interview. It was adopted by Canada, the U.K., and the Fed.

Buffett framed inflation as a tax that hits savers the hardest. "You're saying to people, if you're getting less than 2% on your money, you're going backward," he said. "And actually, if you pay tax, you may pay tax on the 2%."

If you earn 2% interest and pay a 24% marginal tax rate, your after-tax return drops to 1.52%, below the Fed's inflation target of 2%.

Buffett isn't alone in critiquing the 2% target. Paul Volcker, whom Buffett named as one of his "heroes at the Fed," preferred keeping inflation below 1%.

Getting inflation to zero would require keeping rates high enough to choke off even small price increases—at the cost of slower growth and, likely, higher unemployment. The 2% target, formalized by the Fed in 2012, exists because it decided that the cost wasn't worth it.

For one thing, the Fed wants flexibility. When inflation is at 2%, the benchmark rate typically sits around 4% to 5%, giving the Fed room to cut in a downturn. With near-zero inflation, that cushion shrinks, a problem the Fed ran into after the 2008 financial crisis, when it cut to near zero and unemployment still topped 9%. It had to turn to quantitative easing—buying trillions in bonds—to stimulate growth.

Inflation also lets employers adjust labor costs without cutting pay outright—your salary stays flat, but you can buy slightly less. At zero inflation, the only option is layoffs. Researchers at Brookings argue this means lower inflation could permanently raise unemployment by 1 to 3 percentage points.

At zero inflation, cash doesn't lose value to inflation, so the incentive to spend and invest weakens. Japan's "lost decade" of the 1990s is the cautionary tale for economists: Japan's economy, despite better growth since, has never been the same.

For now, with the Iran war threatening an oil shock and tariffs adding on to prices, the Fed's challenge is getting to 2%, let alone zero.