One for all – The ECB’s Inflation Target

The ongoing sovereign debt crisis and the manifold attempts to resolve it imply the possibility that inflation rates in countries of the euro area will differ from one another for an extended period of time. For instance, some propose that the North should accept inflation rates above the euro-area average to ease the burden of adjustment in the South. In order to understand better some of the welfare consequences of proposals like this one, this paper looks into what rate of inflation a central bank should target in a monetary union and what determines a region’s weight in this target. The central bank’s inflation target should reflect the structural characteristics of all countries in the union, and it should weight countries with slow price adjustment more heavily.