No. 119. IS 2% AN OPTIMAL INFLATION RATE? EVIDENCE FROM THE EURO AREA

Published in DISCUSSION PAPERS

A. Caraballo, T. Efthimiadis. 2011.

 

Recent studies have shown that the inflation-Relative Price Variability (RPV) relationship can have monetary policy implications concerning the optimal rate of inflation. This paper examines this issue for the (first) 16 Euro Area (EA) countries, for the period between January 1997 and October 2010. We employ semi-parametric estimations using monthly data for the Harmonized Index of Consumer Prices (HICP) and find that the relationship between inflation and RPV exhibits a U-shape functional profile for the majority of the countries. The optimal inflation rate, defined as the HICP rate that minimises RPV, is also derived for EA individual countries and for EA aggregates (EA, EA12 and EA16). It is formally shown that although the European Central Bank's “below but close to 2%” inflation target is (almost) optimal for the EA average, it is not close to the optimum inflation rate for most of the EA countries.

 

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