Defining inflation: remarkable differences between the ECB and the FED
from Merijn Knibbe
I just watched an INET speech from Jorg Asmussen, member of the board of the ECB. He still seems to be confident that the ECB has the right definition of ´inflation´ and the right inflation target, despite everything which happened to house prices (excluded from their data…). The ECB definition is outdated and obsolete – not just my opinion but also the implicit opinion of the Fed. Time to reblog an earlier post.
As part of the research for a small paper I visited the websites the European Central Bank and the FED. There turns out to be a very marked and remarkable difference in the way they define: ‘inflation”. The ECB very clearly defines price stability as an increase (sic!) in the ‘Harmonized Index of Consumer Prices’, the FED admits that there are more prices than just consumer prices. Note also the difference in tone. The point: economists don’t even agree on how to define inflation – up to the highest level.
First, the ECB (and this objective is ad nauseam repeated in ECB-speeches and again and again presented as the epitaph of ‘modern central banking’):
“Although the EC Treaty clearly establishes maintaining price stability as the primary objective of the ECB, it does not define what “price stability” actually means. With this in mind, in October 1998, the ECB announced a quantitative definition of price stability. This definition is part of the ECB’s monetary policy strategy“
“In October 1998 the Governing Council of the ECB defined price stability as “a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%” and added that price stability ”was to be maintained over the medium term”. The Governing Council confirmed this definition in May 2003 following a thorough evaluation of the ECB’s monetary policy strategy. On that occasion, the Governing Council clarified that “in the pursuit of price stability, it aims to maintain inflation rates below but close to 2% over the medium term”.”
The FED, however, has a more modern, subtle, flexible and scientific approach which gives it leeway to include, among other things, house prices in their analysis (a possibility which, according to the speeches and other material of the ECB, is explicitly rejected by the ECB as it’s according to the ECB not consistent with ‘modern central banking’ to deviate from previous
“Inflation occurs when the prices of goods and services increase over time. Inflation cannot be measured by an increase in the cost of one product or service, or even several products or services. Rather, inflation is a general increase in the overall price level of the goods and services in the economy. Federal Reserve policymakers evaluate changes in inflation by monitoring several different price indexes. A price index measures changes in the price of a group of goods and services. The Fed considers several price indexes because different indexes track different products and services, and because indexes are calculated differently. Therefore, various indexes can send diverse signals about inflation. The Fed often emphasizes the price inflation measure for personal consumption expenditures (PCE), produced by the Department of Commerce, largely because the PCE index covers a wide range of household spending. However, the Fed closely tracks other inflation measures as well, including the consumer price indexes and producer price indexes issued by the Department of Labor. When evaluating the rate of inflation, Federal Reserve policymakers also take the following steps:
•First, because inflation numbers can vary erratically from month to month, policymakers generally consider average inflation over longer periods of time, ranging from a few months to a year or longer.
•Second, policymakers routinely examine the subcategories that make up a broad price index to help determine if a rise in inflation can be attributed to price changes that are likely to be temporary or unique events. Since the Fed’s policy works with a lag, it must make policy based on its best forecast of inflation. Therefore, the Fed must try to determine if an inflation development is likely to persist or not.
•Finally, policymakers examine a variety of “core” inflation measures to help identify inflation trends