Is 3% Inflation the New 2%?

Why fiscal pressures may be keeping the Federal Reserve from finishing the last mile back to 2%

The FOMC’s decision to cut interest rates at its December meeting was not an easy one. Job growth has slowed and inflation remains elevated forcing the Fed to make a tough tradeoff as to which unwanted development is more important. The majority of the committee erred on the side of labor markets.

But not everyone. Fed Presidents Austan Goolsbee of the Chicago Fed and Jeffrey Schmid of the Kansas City Fed wanted to hold off on interest rate cuts until we got more information on the balance of risk. President Goolsbee later explained his decision:

Waiting to take this matter up in the new year would not have entailed much additional risk and would have come with the added benefit of updated economic data which have been absent lately. Given that inflation has been above our target for four and a half years, further progress on it has been stalled for several months, and almost all the businesspeople and consumers we have spoken to in the district lately identify prices as a main concern, I felt the more prudent course would have been to wait for more information.

I highlight this because President Goolsbee’s concern captures a deeper unease that now runs through monetary policy debates. The question facing the Fed is no longer just whether inflation will glide back to 2% with a bit more patience, but whether the economy has entered a world in which inflation is structurally harder to extinguish. December’s decision to cut rates despite stalled disinflation suggests that this possibility is no longer hypothetical—it is increasingly shaping policy choices in real time.

That broader concern is what motivated the Barron’s article below, which I wrote last month but feels even more relevant after the December FOMC meeting. The piece explores why inflation appears to have settled around 3%, why that outcome may be less about fading monetary resolve than binding fiscal constraints, and why the “last mile” back to 2% may be far more than a routine policy challenge. In short, it asks whether 3% inflation is becoming the de facto equilibrium of the U.S. macroeconomic regime.

How 3% Inflation Became the New Normal*

The last mile of a long journey is often the hardest. The Federal Reserve has traveled far in its fight against inflation since it peaked near 9% in 2022. But since the summer of 2023, progress has stalled around 3%. The finish line—that elusive 2% target—remains just out of reach.

This two-year pause in disinflation, coupled with recent rate cuts and the prospect of more to come, has led some to wonder whether the Fed has lost the will to beat back inflation and has quietly resigned itself to a new normal, where 3% is the new 2%. It is more likely, however, that deeper fiscal forces are keeping inflation stubbornly elevated.

Fed officials insist they haven’t given up on their 2% target. Fed Chair Jerome Powell was emphatic about this at the Federal Open Market Committee press conference on Oct. 29. “We are absolutely committed to returning inflation to 2%,” he said. “There should be no question that that is where we are going.”

Economic data tell a different story. Headline inflation remains sticky near 3%, and forecasters expect that to persist. The Blue Chip consensus forecast expects personal consumption expenditure inflation—the Fed’s preferred measure—to hover near 3% through 2026. It won’t fall to 2.1% until 2030. The Philadelphia Fed’s Survey of Professional Forecasters shows even more drift: Both the 5-year and 10-year expected PCE inflation rates are edging higher, moving further away from the 2% anchor the Fed once took for granted.

These trends seem to suggest a softening of the Fed’s inflation target. Fed officials, however, are quick to note that part of the recent uptick in prices reflects the higher tariffs imposed by President Donald Trump. These tariffs, they argue, represent a negative supply shock—a drag on the economy’s productive capacity. In principle, such shocks shouldn’t lead to persistently higher inflation but rather a one-time adjustment in prices that temporarily pushes inflation above target. That is their hope, at least.

That hope isn’t much to hang on. Most supply shocks are, by definition, transitory and cannot explain the persistence of sticky inflation like the kind the U.S. has seen since mid-2023. The notion that a negative supply shock will have only a temporary effect on prices assumes that inflation expectations will remain well anchored.

Fed officials often cite bond market forecasts of inflation as evidence that inflation expectations remain well-anchored. But professional forecasters, as seen above, are beginning to mark up their inflation projections in this area, too.

Even more concerning, households appear to be responding as if the new tariffs will raise future inflation more persistently. Inflation from the Covid-19 pandemic left them scarred, more sensitive to price shocks, and less confident in the Fed’s ability to anchor inflation. Supply shocks, if anything, may now be making inflation stickier than fleeting.

This shift is reflected in the two figures below. The first figure shows one-year-ahead consumer inflation expectations across three major surveys. All three tell a similar story: expectations surge during the pandemic, then fall back, but settle at a level that so far appears structurally higher than before.

Survey responses can always be dismissed as cheap talk. To see whether this concern shows up in actual behavior, we can look at revealed preferences. Google searches for inflation also reveal a notable structural shift: people are now searching for the term at a consistently higher level than before the pandemic.

Fiscal Pressures and the Last Mile Back to 2%

If supply shocks and inflation psychology explain the current stickiness of prices, fiscal pressures explain why they may stay that way. The U.S. is entering a period where fiscal policy, not monetary resolve, increasingly determines the inflation path. With debt projected to climb well above 120% of gross domestic product under current law, and interest costs approaching $2 trillion by the early 2030s, the fiscal math is diminishing the Fed’s room to maneuver.

In such an environment, a 3% inflation rate is less a policy failure than an adaptation—the by-product of an economy adjusting to a chronic government deficit and the political impossibility of fiscal consolidation.

The early warning signs of fiscal dominance are already visible. Trump’s open calls for rate cuts on the grounds that they would “save $800 billion per year” are the clearest expression yet of monetary policy being viewed through a fiscal lens. Similar pressures appear in recent proposals by Republican senators to end interest on reserves as a way to save taxpayers money; in discussions to loosen the supplementary leverage ratio so banks can absorb more Treasuries; and in growing political enthusiasm for stablecoins, precisely because they create new captive demand for government debt.

Even the Treasury’s pivot toward heavier Treasury bill financing points to a world in which market structure, regulation, and innovation are quietly being marshaled to sustain an ever-larger debt load. These are the institutional tremors of a shift from monetary to fiscal dominance, small in isolation but revealing when considered cumulatively.

If this drift continues, the Fed may find that the last mile of disinflation is not just difficult, but unreachable. Once the consolidated government budget constraint begins to bind, the arithmetic of debt service, not the resolve of central bankers, will dictate the equilibrium inflation rate. Higher inflation becomes a feature, not a bug. It is a necessary lubricant for an over-leveraged fiscal state.

The Fed can talk tough, but as long as fiscal pressures dominate, its independence will remain conditional and its 2% goal aspirational. The last mile of disinflation may be the hardest, not because the Fed is weary, but because the road itself now bends toward fiscal dominance.

*The essay above is a slightly altered version of the original Barron’s article published on November 7. Specifically, a few paragraphs were added to allow for the Google Inflation search figure to be included in this essay and a new transition header was added for the fiscal pressures section.