Everyone is talking about deflation. For October Eurostat reported: „Euro area annual inflation rate stable at -0.3%“. The European Central Bank (ECB) could expand its bond purchases in December. In addition, ECB President Lagarde pointed out that inflation in the Eurozone averaged 2.3% before the financial crisis, and only 1.2% since then. What this is due to and how the ECB should react to it should be clarified within the framework of the strategy review.
"Which inflation?", one should ask first. Because there are different measures of inflation. The figures refer to the Harmonized Index of Consumer Prices (HICP), which the ECB has placed at the heart of its strategy. But first of all, it does not cover all prices - capital goods, construction costs or government services are excluded. Secondly, it includes imported goods and services, including oil and gas. Measured deflation, for example, is mainly due to the decline in energy prices. Thirdly, the HICP does not capture one important block of household expenditure: the cost of housing for owner-occupied property.
It would make sense to look at the price development of all goods and services produced in the euro area. This is the GDP deflator. Measured against this, inflation averaged 2.0% between 1999 and the first quarter of 2009. Not much difference to the HICP. But that has changed. Until the beginning of 2013, when the euro crisis followed the global financial crisis, prices for domestic goods and services rose by an average of only 1%. During the economic recovery from mid-2013 to early 2020, domestic inflation measured in this way averaged 1.3% and rose to 1.8% by the end of 2019 - i.e. at the ECB's target value of below but close to 2%.
However, the ECB does not talk about the GDP deflator, only about the HICP. During the recession years, the HICP went up and down, averaging 1.8% plus. In the recovery phase since 2013, the average value fell to 0.9%. This is surprising, because according to economic theory as well as empirical observation, inflation falls during a recession and rises in the course of economic recovery. This development is reflected in the GDP deflator. For the ECB, it should also be gratifying that the massive easing of monetary policy is having some effect. The reason for the contrary development of the HICP is the import price inflation of -0.3% on average between 2013 and 2019.
The ECB should therefore look at broader measures of inflation. This is even possible without a major change in strategy. This is because the inflation target of below but close to 2% for the HICP can be interpreted as a range of 1.5 to 2%. This gives flexibility to include signals of other measures of inflation in the communication. This also applies to the price trend for owner-occupied housing. Over the past five years, the annual increase in these costs in Germany has fluctuated between 3% and 5%. It is methodologically difficult to include the costs of owner-occupied housing in the HICP. But this does not have to prevent the ECB from taking this into account in monetary policy and communication.
A shorter version appeared as opinion-piece in Handelsblatt:
Volker Wieland im Homo Oeconomicus: Inflation ist nicht gleich Inflation - Die EZB sollte andere Maße betrachten