Optimal Rate of Inflation in Hungary
AbstractThis paper, requested by the Monetary Council, attempts to determine the level of inflation consistent with price stability, taking into account the characteristics of the Hungarian economy. Price stability is defined as the level of inflation that allows the maximisation of social welfare on a 15-20 year horizon, which corresponds to the first phase of real convergence. In other words, this study aims to determine the inflation rate that can be considered optimal within the given time horizon. In developed countries, the primary objective of central banks is the maintenance of price stability, in view of the welfare costs of inflation. Price stability is usually taken to mean a low, but non-zero, inflation rate. A positive inflation rate can be justified since very low inflation rates, in the proximity of zero, have been found to reduce long-term welfare. The negative welfare effect of zero inflation can be explained in terms of the following: asymmetric nominal rigidities, the risk of deflation, the necessity of positive nominal interest rates, and the statistical measurement bias in the CPI. These factors were examined in light of the catching-up status of Hungary, focusing, in particular, on the question of whether or not, due to its catching-up status, the optimum rate of inflation in Hungary is higher than the 1-2,5% inflation rate defined in developed countries. The findings of the study suggest that the inflation rate corresponding to price stability in Hungary is higher than the inflation target of the European Central Bank. Our calculations suggest that, in the long run, inflation in the range of 2,3-3,2% can safeguard against the costs of deflation. This level can compensate for the distortions in the CPI and allow for real price adjustments, even if Hungarian tradable prices move together with those of its trading partners and assuming downward price rigidity.
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Bibliographic InfoPaper provided by Magyar Nemzeti Bank (the central bank of Hungary) in its series MNB Background Studies (discontinued) with number 2004/1.
Length: 33 pages
Date of creation: 2004
Date of revision:
optimal inflation rate; price stability; costs of inflation.;
Find related papers by JEL classification:
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
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- András Rezessy, 2006. "Considerations for setting the medium-term inflation target," MNB Bulletin, Magyar Nemzeti Bank (the central bank of Hungary), vol. 1(2), pages 35-40, December.
- Dubravko Mihaljek & Sweta Saxena, 2010. "Wages, productivity and "structural" inflation in emerging market economies," BIS Papers chapters, in: Bank for International Settlements (ed.), Monetary policy and the measurement of inflation: prices, wages and expectations, volume 49, pages 53-75 Bank for International Settlements.
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