Home > The Economics Profession > Defining inflation: remarkable differences between the ECB and the FED

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 The ECB definition is outdated and obsolete – not just my opinion but also the implicit opinion of the Fed.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 mistakes goals):

“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

  1. December 16, 2011 at 5:16 pm

    Quantitative analysis to discern quality of life is tough. Life on earth is a self-aware thermodynamic chemical process entering emergency survival mode, with an expectably large financial storm. An increasing contributor to inflation is increasing environmental friction from ecological decay. Lies and propaganda from governments are proudly ignoring information-age hopes for civilization as expressed by the most educated humanity ever to exist. Horizontal leaderless democracy extending into the economy with complete human knowledge and awareness directed to ecological consequences is one theme. How little we will loose as we abandon the vector to certain mayhem? How much will we gain from a planet returned to health? The answer cannot be fully foretold. Que será, será. The future is not ours to see. Even so, Humanity knows the direction to living well in harmony with Earth, the idea is to use qualitative analysis to re-direct quantitative measurement toward life events with actual effects on living well.

    • merijnknibbe
      December 16, 2011 at 8:38 pm

      I’ll use the last sentence

  2. December 16, 2011 at 11:13 pm

    “economists don’t even agree on how to define inflation – up to the highest level.”

    First of all they should stop calling “price increases” “inflation”. Then perhaps a clearer definition could emerge.

    Price Increase
    Unless we have lots of money devaluing as savings, the measure that matters to most of us is the spread between the bottom to middle tiers of incomes and the prices of necessities. That is what a real “price increase” is. Our incomes are no longer sufficient to buy what they used to. The same effect is realized from a general drop in incomes relative to stable or even decreasing prices so a true “price increase” is very clearly distinct from “inflation”.

    I think that the word “inflation” should be constrained to its proper meaning which is “monetary inflation”. This is the total amount of legal tender money and money-denominated credit actually in circulation, in relation to the need for that money, which might be determined as total money / GDP without reference to any specific set of prices at all.

    Defined this way monetary inflation cannot be hidden as “price increases” that “just happen” when it is really “currency devaluation” by design.

    • Alice
      December 17, 2011 at 8:27 am

      As someone else mentioned somewhere in this blog…the obsession with inflation is part of the problem and now 40 years out of date. Is it possible at all for the obsession with IMHO “a false mneasure of inflation” to end and economics starts to address the real economics problems we now face like unemployment and lack of demand. The issue of productivity and flexibility in the labour force also needs a mention here as two white elephant sacred cows of neoclassical economics. The labour force is now so flexible many only work two days or three days a week on barely subsistence wages – whole demographics like the young etc. Permanent and secure jobs are almost antique but what has that delivered except a king hit to aggregate demand?. How can people so damn flexible they are working for peanuts and fewer hours than they actually want, consume much at all?. If people had more decent hours and protections in the workforce maybe they would have the wherewithall to trickle it around much better than the rich have been trickling down,

      As someone else said in this blog – the rich dont realise it yet but even they will be affected by these poor policies. The obsession with a false measure of inflation is well past its use by date.

    • merijnknibbe
      December 17, 2011 at 11:21 am


      I. I completely agree that we should track the increase of the amount of money – which is what we do, in fact (though it does undescore the differences between the ECB and the FED that the ECB has a 4,5% increase of M-3 as its official goal while the FED doesn’t even estimates M-3 anymore. But Shadow Statistics does. EZ as well as USA data by the way show a very subdued increase of money (Greek data are in fact horrible: double digit decreases of M-1 – which means that people just can’t pay their bills anymore and are running up debts).


      For the dogged adherence of the ECB to their 4,5% goal one could consult the ECB Monthly Bulletin – a worse example of ‘mechanical economics’ will be hard to find (chart 14 and 15 – this is the ‘Gap’ and ‘Overhang’ which Trichet used to mention in his speeches. Again: based upon M3 which is not even estimated anymore by the FED (very good thing that the ECB publishes these measures, by the way. The Bulletin does contain a caveat, but that never seems to have hampered Trichet: hydraulic monetarism)

      Click to access mb201112en.pdf

      II. However – I propose to the continue to use the phrase ‘inflation’ to define the increase of the price level/price levels – as that’s what most people do. Based upon the National Accounts expenditure of households is estimated which is the basis for the consumer price index which in fact does not track the ‘price level’ but which does track the purchasing power of household income. There are quite some caveats (differences in income, social position (elderly on social security/people with a job), quality changes (for better or worse) – but it’s the best we have. It does seem to enable it if purchasing power increases or decreases.

      Maybe we should be more precise and use phrases like: ‘inflation of the amount of money’ and ‘inflation of the price level’.

  3. December 17, 2011 at 9:27 pm

    As essential resources become increasingly scarce while human population continues to expand, the prices of scarce resources will rise relative to incomes. This is a true price increase and I expect true price increases to accelerate over the long term as we exhaust the Earth’s carrying capacity.

    I have a historical graph (1960-2009) of the price spikes of oil plotted against Total Debt and sectoral debt. Whenever oil prices sharply increased, creation of new Total Debt (money supply) flatlined or was reduced. New borrowing by most sectors also flatlined or declined.

    An oil price spike is a fundamental commodity price increase that is passed onto almost all other prices, as a genuine price increase relative to incomes. This produces fundamental monetary deflation due to reduced borrowing. General price levels go UP due to a real root-level supply problem, causing the money supply to go DOWN due to pessimistic prospects for the future. The way I see it, this is the dynamic that will apply for ALL of the foreseeable future.

    Reduced borrowing, if persistent, soon leads to mathematically inevitable defaults, dropping asset values, Recession, unemployment, more defaults, bailouts by taxpayers, sovereign defaults, Depression and ultimately complete collapse.

    I have put forth my own simple-arithmetic analysis to prove that any slowdown of total borrowing must cause mathematically inevitable defaults.

    My original cartoon movie Money as Debt was published in early summer, 2006 (revised in 2009) and predicted the planet soon being devoured by a “debt monster” it cannot escape.

    Money as Debt II was meant to be predictive of the 2007-8 collapse but it took me 3 years to complete (2009) and so became after-the-fact analysis. During the making of it, I challenged a list of 35 economics and money system reformers to debate my reasoning with me. No takers.

    View all my movies for free at this link.

    So far, to my eyes at least, events have proven my analysis to be accurate. The link below is to the written version:

    The Banking System, Itself, is the ROOT CAUSE of Money System Instability

    In this article, I set out in words the argument that I presented as an animated cartoon in Money as Debt II – Promises Unleashed. I claim that the design of the banking system itself necessarily creates an ongoing shortage of Principal that results in INSTABILITY and potential COLLAPSE of the system in the absence of PERPETUAL DEBT GROWTH. I claim that this occurs, even in the theoretical case of a COMPLETE ABSENCE of INTEREST and with ALL PAYMENTS BEING MADE in full and on time.

    I have invited people to examine this written proof and comment on or disprove it, including two other Blog Authors of this Review. No one has challenged it yet. YOU could be the first!

    Millions have watched my movies, in 24 languages in 7 alphabets.



  4. Keith Wilde
    December 18, 2011 at 1:35 pm

    A very interesting exchange. As an early adopter of an energy-entropy-ecological perspective, I have always been aggravated by glib reference to inflation as simply increase in prices and have insisted, if the auditor permitted, on inserting the money supply “correction”. The different meanings have become acute with the prospect of deflation and the presence of a liquidity trap. When critics of spending policy howl that it would be inflationary, which meaning to they have in mind? In day-to-day conversation, they seem to be the same people who mean “increase of the price level”. Thus they adopt a monetary view as in the Fisher equation and ignore the real factors that affect the cost of producing and living. I do believe that economists would perform a public service if they adopted the suggested distinction, ‘inflation of the amount of money’ and ‘inflation of the price level’.

    • December 22, 2011 at 7:31 pm

      Allow me to suggest simple definitions:

      ‘inflation of the amount of money’ = Money “stock” (money in circulation) relative to money use in production/consumption (GDP)

      ‘inflation of the price level’ = Prices of necessities (like energy, food, housing, minerals, timber etc.) relative to the average income from all sources of the lower-income majority (the 99%)

  5. April 15, 2012 at 10:33 pm

    To take it a step further: Inflation of price level should be presented, with the help of current technology, as a three dimensional graph, with commodity types spread out along the x-axis, price levels on the y-axis and time on the z-axis.

    You would then see a three dimensional “landscape” which would give a far more meaningful picture of price level movements than a single number at any given time.

  6. Geoff Davies
    April 16, 2012 at 12:31 am

    Good discussion.

    Paul makes a key distinction between the effects of money supply and the effects of commodity prices, and this gets to the way many economists have lost sight of the real, productive economy and only see money flows (which they still quite misunderstand, but that’s Steve Keen’s story).

    This became evident to me during the “oil price shock” of the 1970s (long before I became involved in economics). The resulting price increases were called inflation, but the price increases represented the fact that it was now harder to make a living. To see this you have to see through the money, which facilitates the real economy, to the real economy, which involves production and exchange. The effort required to produce is greater as raw materials become harder to get. This is then reflected in monetary terms as raw materials being more expensive relative to other things, and incomes reduced (or prices increased, the same thing).

    Thus there is a fundamental distinction between (1) a real increase in the effort (“cost”) required to produce and (2) an increase in the money supply that then requires us to use more money to buy things. They may not be trivial to measure, but the distinction must be made.

    Another thing that has amazed me about inflation measures is that housing prices are not automatically included. For most people the cost of mortgage/rent is a major expense, and the practical reality is that recent rapid housing price increases have reduced their effective income.

    Finally, Paul your comments about the “need” for continuing borrowing suggests to me that you’re assuming money can only come from loans, as in our present dysfunctional system. However money can be issued independently of loans and a steady (and small) amount of money would suffice for a steady-state economy. I’ll look at your sources and perhaps offer the challenge you seek. You can see my stuff at http://betternature.wordpress.com/.

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