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Divergent Optimal Inflation Rates In Euro Area Countries Or "Does One Size Fit All?"

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  • Mª Ángeles Caraballo
  • Tilemahos Efthimiadis

Abstract

The aim of this paper is to derive the optimal inflation rate for the Euro Area (EA) countries from the relationship between relative price variability (RPV). In order to achieve the above stated goal, we have utilized monthly data for the Harmonized Index of Consumer Prices between January 1997 and October 2010 for the first twelve EA countries and for the EA aggregate. In a first stage, parametric and semiparametric estimations allow us to find that the inflation-RPV relationship shows a U-shape functional profile for the majority of the countries. In a second stage, within this benchmark and using both kinds of estimations, we obtain the optimal inflation rate defined as the one that minimises RPV. Moreover, we test the sensitiveness of our results to the time period and, for semiparametric estimation, to the bandwidth selected.For EA individual countries and for EA aggregate, it is formally shown that although the European Central Bank's “below but close to 2%” inflation target is (almost) optimal for the EA average, it is not close to the optimum inflation rate for most of the individual EA countries.

Suggested Citation

  • Mª Ángeles Caraballo & Tilemahos Efthimiadis, 2012. "Divergent Optimal Inflation Rates In Euro Area Countries Or "Does One Size Fit All?"," EcoMod2012 3923, EcoMod.
  • Handle: RePEc:ekd:002672:3923
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    References listed on IDEAS

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