DP16828 The Case for a Positive Euro Area Inflation Target: Evidence form France, Germany and Italy

Author(s): Klaus Adam, Erwan Gautier, Sergio Santoro, Henning Weber
Publication Date: December 2021
Keyword(s): micro price trends, optimal inflation target, Welfare
JEL(s): E31, E52
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16828

Using the micro price data underlying the Harmonized Index of Consumer Prices, we estimate relative price trends over the product life cycle in France, Germany and Italy. We show that minimizing the welfare consequences of relative price distortions in the presence of these trends requires targeting a significantly positive inflation rate:the steady-state inflation rate jointly maximizing welfare in all three countries ranges between 1.1%-1.7%. The optimal target range for individual countries is 1.1%-2.1% in France, 1.2%-2.0% in Germany and 0.8%-1.0% in Italy. Differences across countries emerge due to systematic differences in the strength of relative price trends. The welfare costs associated with targeting an inflation rate of zero in the Euro Area, as suggested by standard monetary models without relative price trends, amount to 4.5% of consumption in present-value terms.