The recent fall in both headline and core inflation in the euro area has increased pressure on the European Central Bank (ECB) to adopt further measures to stimulate the economy. With headline inflation turning negative for two months, additional measures seem to be warranted. However, inflation data based on consumer prices should not be the only guide for policy in the kind of turbulent times we are currently experiencing. A broader price index such as the GDP deflator provides important additional information for policy decision.[1] This broad indicator is increasing at a rate of around 2%. There seems to be no danger of broad-based deflation.
How to measure price stability?
The main aim of the ECB is to preserve price stability, which it has defined as an inflation rate of “below, but close to 2%”. To calculate the inflation rate, the ECB uses the harmonised index of consumer prices (HICP). This is harmonised across countries and covers the consumption baskets of representative households. Changes in HICP captures changes in purchasing power that can affect aggregate demand and consumption in particular. For this reason, it is a key variable for public perceptions of price developments and can be more easily understood than the more abstract concept of the GDP deflator. This is why it has been adopted by the ECB as the reference metric. Likewise, measures of expected inflation-based consumer prices vary widely, both in the form of surveys and those derived from inflation-protected bonds (which are based on measures of the consumer price indices (CPI), rather than the GDP deflator). (...)
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