NDEGRI as an alternative to the inflation targeting

Effects of enforced low inflation. For some time it has been believed in European Union, that the optimum inflation level should be close to  2%. Enforcing such low inflation rates, especially in the countries which do not have a long tradition of low inflation, puts them in danger of falling into the so-called low-inflation trap. In these countries implementation of disinflationary policy  in order to achieve the inflation rate at the level of an ambitiously set inflation target may result in negative output growth and temporary unemployment growth. Consequently, low inflation can be accompanied by a tendency towards higher budget deficit.  The need to anchor inflationary expectations at the level of an ambitiously set inflation target enforces a tendency towards maintaining excessively high interest rates, which can, in turn, cause a long-lasting stagnative tendency at low inflation rates and incomplete capacity utilization. Economy becomes a specific hostage of good-looking inflation statistics and is stuck in the low inflation trap. Maintaining artificially reduced inflation indexes (following the “price leader”) becomes the target in itself whereas economic growth becomes less important.

Neutral inflation. An alternative model of determining the inflation target by the ECB could be based on the concept of the so-called neutral inflation or Non-Decelerating Economic Growth Rate of Inflation (NDEGRI), understood as an average – over the period of 5-10 years – price rise which co-exists with the highest indicators of economic growth and the degree of capacity utilization (the highest indicators of economic success (ESI),  at which inflationary expectations are of stable character (i.e. inflation does not tend to accelerate). Adoption of so modified a mechanism of the ECB’s inflation target determination could contribute to „releasing” of the most dynamic economies of the Eurozone  and countries aspiring to join it from the specific burden which their dependence of the development rate on the ”unnaturally” and arbitrarily established inflation target may pose for them.

NDEGRI level estimates for developed countries. It is difficult to estimate the current NDEGRI level with respect to particular Eurozone member countries since in recent years both the economic growth rate and the degree of capacity utilization as well as the dynamics of inflation in these countries were determined by common monetary policy which effectively distorted natural relationships between these indicators appearing in particular economies. Preliminary comparative research conducted so far into the economies of the Euroland, United States and Japan allows to conclude indirectly that the NDEGRI level in the industrialized countries is closer to 3 rather than 2 per cent as in the 1989-2008 period American economy noted the ESI higher by ca. 37% ( 3.2 and 1.9, respectively) than those noted in the Euroland countries at average annual inflation values higher by ca. 10%. The example of Japanese economy indicates also, that  low inflation does not have to be a good foundation for fast economic growth.