The Eurosystem’s price stability objective
According to the Eurosystem’s definition, price stability is a year-on-year increase in the Harmonised Index of Consumer Prices (HICP inflation) for the euro area of 2% over the medium term. A clearly defined and publicly announced inflation target has the following advantages:
- It contributes to a better understanding of the Eurosystem’s monetary policy framework and makes its monetary policy more transparent.
- It provides a clear yardstick against which the public can objectively measure the Eurosystem's performance.
- It provides a clear anchor for inflation expectations.
By setting an inflation target of 2%, the ECB's Governing Council has an inflation buffer above 0%, which
- provides monetary policy with space for interest rate cuts in the event of adverse developments;
- provides a safety margin against the risk of deflation through its positive impact on the trend level of nominal interest rates;
- facilitates cross-country macroeconomic adjustment within the euro area;
- creates room for real wage cuts that may be needed under certain circumstances to mitigate downward nominal wage rigidities that might otherwise prevent a swift recovery from adverse macroeconomic shocks; and
- provides a safety margin against the risk of deflation, should errors in inflation measurement lead to an overestimation of actual price developments.
The Eurosystem’s monetary policy is focused on the entire euro area. Hence, its assessment of price stability is based on price developments in the euro area as a whole – not price developments in individual euro area countries.
The Eurosystem’s definition of price stability is tied to the Harmonised Index of Consumer Prices (HICP) for the euro area. This index has been harmonized across the euro area.
According to the ECB’s Governing Council, its price stability target is to be understood as symmetric, meaning that negative and positive deviations of inflation from the target are equally undesirable.
The transmission of monetary policy impulses to the real economy, and the price level in particular, takes a considerable amount of time. Monetary policy cannot influence the inflation rate over the short term. For this reason, medium-term orientation is an important element of the definition of price stability.