Europe faces tough 2% inflation target

The planned European Central Bank may settle on an inflation target of zero to 2 per cent, it emerged yesterday, writes Yvette Cooper. This could be tougher than the current UK inflation target of 2.5 per cent, depending on how the new Bank decided to measure inflation.

A new report from the European Monetary Institute (EMI), the forerunner of the European Central Bank says: "It will be useful for the European System of Central Banks to announce a definition of price stability ... there has been a broad consensus among central banks ... that a range of zero to 2 per cent inflation per annum would be appropriate." The Maastricht Treaty specifies that the primary objective of the European Central Bank must be "to maintain price stability".

The report, The Single Monetary Policy in Stage Three, was put together by the EMI in conjunction with European central banks, including the Bank of England. It says: "No unconditional recommendation can be given at this stage for the strategy of the ESCB." However, the report does say that monetary policy should involve either monetary targeting or inflation targeting or some combination of the two. The Bundesbank currently targets the money supply. However, this might be difficult in the first few years of EMU while the relationship between measures of euro money supply and inflation remains unstable.

The EMI states: "The ECB should publicly set targets against which its performance can be assessed."

Given the "consensus" among European Central Bankers that price stability means inflation of zero to 2 per cent, this suggests that if the ECB chooses an inflation target it is likely to be 2 per cent or less. But the crucial question remains which measure of inflation would be set against the target.