The collective wisdom in monetary policy circles identifies the optimal inflation rate as somewhere between 1% and 3%, with 2% being a popular target. Ideally, in normal times, this range provides sufficient wiggle room for real prices and wages to adjust if their nominal counterparts are a bit rigid—typically in the downward direction. In other words, let’s say wages and prices don’t readily decrease, be it for technical or psychological reasons. Then it’s best to have a little bit of inflation so that, even if nominal wages and prices stay constant, they can still decrease in relative terms if that’s what’s required for markets to stay in equilibrium. More inflation is not ideal, though, because of the significant associated costs: for example, if prices need to be readjusted frequently or allocations between cash and financial assets become distorted.
So how well do central banks throughout the world achieve this goal? The graph shows the G7 countries, which all target an inflation rate of around 2%. It looks like only Japan is capable of getting inflation high enough right now, which is ironic because Japan has suffered from deflation or zero inflation for over a decade. Of course, this collective “failure” may be related to the past year’s large decrease in commodity prices, especially oil. Unless this trend continues over the next year, we should see inflation rates getting closer to where central bankers want them.
How this graph was created: The data shown in the graph are from the OECD’s Main Economic Indicators. The most direct way to find them is to search for “oecd cpi monthly growth rate from previous period.” Select the series you want and use the “Add to Graph” button to display them. Finally, restrict the sample period to the past five years.
Suggested by Christian Zimmermann
