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Is 2 % the optimal inflation rate for the Euro Area?

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Abstract

According to the relevant literature, monetary policy implications concerning the optimal inflation rate can be derived by examining the relationship between inflation and the Relative Price Variability (RPV). This paper studies this issue for selected Euro Area (EA) countries, using monthly data for the Harmonized Index of Consumer Prices. In particular, semi-parametric estimations are employed so as to find the accurate form of the inflation-RPV relationship. The results indicate that this relationship exhibits a U-shape functional profile. Furthermore, the optimal inflation rates for the EA, France, Germany and Spain are also calculated. For all countries and the EA, we find that although the European Central Bank’s “below but close to 2 %” inflation target is optimal for the EA average, it is not the optimum inflation rate for the individual counties.

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Notes

  1. According to the Maastricht treaty (1992), the ECB’s main task is to ensure price stability. The ECB defines this task as “the year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the Euro Area below, but close to 2 % over the medium term” (ECB 2004). However, amongst others, Fendel and Frenkel (2009) find that when EA inflation differentials were high, the ECB was reluctant to combat inflation.

  2. See Sheshinski and Weiss (1977), Rotemberg (1983) and and Caplin and Leahy (1991).

  3. See Caraballo and Dabús (2008) for a review of the literature.

  4. As our data sample ends in 2010, Estonia is not included as it joined the EA in 2011.

  5. In other words, in what follows, RPV alone refers to RPV-3 digits.

  6. This methodology is similar to that of Fielding and Mizen (2008) and Caraballo and Dabús (2012).

  7. In Fig. 1, MSFE has been multiplied by 106.

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Authors and Affiliations

  1. Departamento de Economía e Historia Económica, Universidad de Sevilla, Avda. Ramón y Cajal nº1, 41018, Sevilla, Spain

    Ma Ángeles Caraballo

  2. Centre of Planning and Economic Research, Athens, Greece

    Tilemahos Efthimiadis

Authors
  1. Ma Ángeles Caraballo
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  2. Tilemahos Efthimiadis
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Correspondence to Ma Ángeles Caraballo.

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Acknowledgments

The authors thank two anonymous referees for their valuable comments, as well as financial support from Junta de Andalucía (CICE, Proyecto de Excelencia SEJ-4546). The usual disclaimer applies.

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Caraballo, M.Á., Efthimiadis, T. Is 2 % the optimal inflation rate for the Euro Area?. Int Econ Econ Policy 9, 235–243 (2012). https://doi.org/10.1007/s10368-012-0212-9

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