This decision reflected the FOMC’s judgment that inflation that persistently deviates – up or down – from a fixed low level can be costly in a number of ways. Persistent high inflation induces households and firms to spend time and effort trying to minimize their cash holdings and forces businesses to adjust prices more frequently than would otherwise be necessary.
More importantly, high inflation also tends to raise the after-tax cost of capital, thereby discouraging business investment. These adverse effects occur because capital depreciation allowances and other aspects of our tax system are only partially indexed for inflation.