Working Paper: CEPR ID: DP16828
Authors: Klaus Adam; Erwan Gautier; Sergio Santoro; Henning Weber
Abstract: 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.
Keywords: optimal inflation target; micro price trends; welfare
JEL Codes: E31; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal inflation rate (E31) | welfare costs (I30) |
| targeting a significantly positive inflation rate (E52) | minimize welfare consequences due to relative price distortions (D69) |
| steady-state inflation rate (11%-17%) (E31) | welfare costs (I30) |
| higher inflation target (E31) | counteract relative price distortions (F16) |
| optimal inflation rate (E31) | account for negative trend in relative prices (E31) |
| positive correlation in relative price trends (France and Germany) (F14) | optimal inflation rates (E31) |