The Eurosystem’s price stability objective
The Eurosystem considers that price stability is best maintained by aiming for 2% inflation in the euro area over the medium term. It considers the Harmonised Index of Consumer Prices (HICP) to be the appropriate measure for assessing this objective. 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 important guidance so households and businesses can better plan their consumption and investment decisions.
As inflation in general involves costs for households and businesses, keeping it as low, predictable and stable as possible is important. Yet, there are good reasons why, by setting an inflation target of 2%, the ECB's Governing Council has decided in favor of an inflation buffer above 0%. The 2% inflation target
- provides monetary policy with space for interest rate cuts aimed to minimize the risk of deflation in the event of adverse economic developments;
- facilitates cross-country macroeconomic adjustment within the euro area;
- creates room for real wage cuts that may be needed because of downward nominal wage rigidities in order to enable 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 focuses on the entire euro area. Hence, its assessment of price stability is based on price developments in the euro area as a whole – not on price developments in individual euro area countries.
The Eurosystem’s definition of price stability is tied to the Harmonised Index of Consumer Prices (HICP). HICP inflation means the year-on-year percentage change in the HICP. It is a measure of changes in the prices of goods and services consumed by households. This index has been harmonized across the euro area.
According to the Governing Council of the ECB, 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. This is why medium-term orientation is important in defining price stability.