The case for a positive euro area inflation target: Evidence from france, germany and italy

Abstract

Using micro price data underlying the consumer price index, we estimate relative price trends over the product life cycle in France, Germany and Italy. 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 welfare costs of targeting an inflation rate of zero, as suggested by monetary models ignoring relative price trends, or of targeting 4% amount to several percentage points of consumption.