Report
What additional fiscal space in the euro zone if the inflation target is raised to 3%?
We are looking at a situation where: The euro-zone inflation target is raised from 2% to 3%; Spontaneous inflation, excluding the effect of monetary policy, in the euro zone is slightly lower than 3% (2.8% for example). Looking at past developments, we believe that raising the inflation target from 2% to 3%, on the basis of spontaneous inflation of 2.8%, would reduce the real short-term interest rate by 250 basis points and the real long-term interest rate by 200 basis points. This 200 basis point fall in the real long-term interest rate, due to the 100 basis point increase in the inflation target, would allow for an increase in the fiscal deficit of 1.9 percentage points of GDP without increasing the public debt ratio.
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