A Review of Optimal Inflation Targeting, What Should Be the Threshold Inflation Target?

Abstract

Although it is widely acknowledged that most of developed countries have inflation targeting in order to control sustainable economic growth these review attempted to answer some questions about the optimal inflation target foe the European central bank. The review was made based on secondary data from Eurostat data base, different articles and annual reports of the central bank of Europe.We found that the threshold inflation target to be in the form of interval with an upper bound of 4 percent and lower bound of 2 percent. Based on the objectives of maintaining sustainable economic growth in the region, the threshold level of inflation is found to be 11 - 16 percent per year for low income countries, 15 - 21 % per year for lower middle-income countries, and 4 - 5 % for upper middle-income countries. Hence, 2 % as well as 4 % of current upper bound of inflation target in Euro Area fall within this range. The interval from 0 percent to 2 percent is reasonable because low positive inflation is easier for firms to decrease real wages to maintain employment (downward rigidity) when it is necessary without reducing nominal wages. Accordingly, the measures taken by ECB[1] to deal with the problem active quantitative easing program (QE), as shown in the experience of USA, UK and Japan, are not solely efficient.

Keywords: European central Bank, Sustainable economic growth, Inflation Targeting

DOI: 10.7176/JESD/10-3-09

[1] European Central Bank