Euro zone: Is 2% inflation really preferable to 1% inflation?
The ECB continues to fight to drive up euro-zone core inflation to 2%, while it remains close to 1%. But can we be certain that an inflation rate of 2% is better than 1%? If household incomes (wages, pensions) are only partially indexed to inflation, then a rise in inflation from 1% to 2% reduces household purchasing power; A rise in inflation increases the inflation tax; But, given the likely inflation measurement error (overvaluation of services prices) and the Balassa-Samuelson effects (gap between price rises in industry and services), an inflation rate of only 1% may lead to deflation in certain sectors; Lastly, an inflation rate of 1% leads to an equilibrium with low nominal interest rates, and to a limited capacity to cut rates if necessary because of the zero lower bound of nominal interest rates. The under-indexation of certain incomes to prices is therefore the only argument that would be positive for inflation remaining at 1%; an increase in the inflation tax is positive for the government and negative for private economic agents; the other arguments (risk of deflation, limited potential for fall in nominal interest rates) are in favour of an inflation rate of 2% .