CONICET | Buscador de Institutos y Recursos Humanos

This paper studies the relation between inflation and relative price variability in Spain. Our central findings are that this presents a U-shape profile and a significant structural change at the entry of Spain into the European Monetary Union (EMU), as well as that the annual optimal inflation rate is around 4%, which is higher than the 2% admissible by the EMU mandate. Thus, the main policy implication is that disinflation efforts to achieve the target level would result in welfare loss. In turn, the key link between inflation and price dispersion is unexpected inflation. Likewise, our results suggest that monetary policy matters: welfare costs associated with higher price dispersion can be minimized with a credible and predictable inflation targeting policy.