This paper introduces a new method for tuning the power filter for enhancing the stability and transient response of a droop controlled microgrid system based on inverter-interfaced Distributed Generators (DGs). To tackle the stability issue of such a microgrid, faster and more robust droop controllers are required. Thus, the delay and phase shift imposed by the Low Pass Filter (LPF), which is incorporated in the power controller of inverter-based DGs, should also be minimized. In this context, the purpose of this paper is two-fold: a) to show that a tunable power filter with a cutoff frequency below the fundamental frequency can improve the performance of an islanded droop controlled DG microgrid, and b) to suggest a filter tuning method. A comprehensive study is carried out by means of small signal analysis in order to assess the impact of the power filter on the system's eigenvalues. The mathematical analysis shows that the proposed technique results in efficient damping of oscillations following system disturbances. The simulation results verify the superior performance of the proposed approach in terms of improving the transient response and the small signal stability of the islanded DG microgrid during the startup and load excursion operations.