Estimating the implicit inflation target in the Euro area

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Estimating the implicit inflation target in the Euro area

Author Info

Fève, P.
Matheron, J.
Sahuc, J-G.

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Abstract

Euro area countries as a whole have experienced a marked downward trend over the 1980s. Over this period, the unemployment rate has increased and economic activity has been sluggish. Changes in the implicit inflation target, viewed as low frequency movements of inflation, might possibly explain these developments. To highlight this issue, the present study estimates the dynamics of the implicit inflation target in the euro zone over the period 1970Q1-2004Q4. Based on a small macroeconometric model, the implicit target, not known by the econometrician, is identified through a minimal set of theoretical restrictions: (i) the inflation target is a non stationary process, (ii) inflation is a monetary phenomenon in the long-run, and (iii) changes in the implicit target have no long-run effects whatsoever on real variables. The model is estimated so as to match output growth, changes in inflation and the ex post real interest rate. Our main results are: (i) inflation target shocks account for the bulk of nominal fluctuations; (ii) due to monetary policy inertia and nominal stickiness, changes in the target generate large swings in the real interest rate translating into substantial short-run effects on real variables; (ii) in spite of this inflation target shocks moderately impact on output dynamics.

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Publisher Info
Paper provided by Banque de France in its series Documents de Travail with number 246.

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Length: 19 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:bfr:banfra:246

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Find related papers by JEL classification:
E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

This paper has been announced in the following NEP Reports:

NEP-ALL-2009-10-24 (All new papers)
NEP-CBA-2009-10-24 (Central Banking)
NEP-EEC-2009-10-24 (European Economics)
NEP-MAC-2009-10-24 (Macroeconomics)
NEP-MON-2009-10-24 (Monetary Economics)

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