Monetary policy

Why has the inflation target been set at 2%, rather than at 0%?

A price growth rate of 2% is low enough to fully reap the benefits of price stability and, at the same time, it provides a margin to reduce the risk of deflation.

In addition, since euro area inflation is measured as a weighted average of the inflation of all member countries, the 2% target enables the implications of any differences between countries to be addressed. Having a target of 0% would mean there being some countries with negative inflation rates, i.e. deflation.

The 2% target also helps avoid measurement problems. When calculating the Harmonised Index of Consumer Prices (HICP), price growth may be overestimated due to a small positive bias in measuring changes in price levels, owing to, among other reasons, the difficulty of factoring in product quality improvements.

Lastly, the 2% target provides some space for nominal interest rates vis-à-vis the effective lower bound. Since, in the long run, nominal interest rates are equal to equilibrium real interest rates plus inflation expectations, the higher the inflation target (assuming it is credible), the higher inflation expectations will be. This will lead to higher nominal rates and, therefore, more space for reducing them if needed before they reach their effective lower bound.