This Great Graphic is composed on Bloomberg. It shows two time series. The headline CPI is the white line. It has gone negative, and when the flash estimate for January is released at the end of the week, it is likely to have fallen further. The Bloomberg consensus is for a -0.5% reading.
The other time series, the yellow line, shows core inflation. It is considerably less volatile. Each month in Q4 14 it was at 0.7%. The Bloomberg consensus expects it to have remained there in January.
The ECB focuses on headline inflation. It has given poor signals in the recent past. It spurred former ECB President Trichet into engineering rate hikes in 2008, just as the eurozone economy fell into recession. And again, relying on headline inflation hiked rates in 2011.
The ECB is given a mandate of price stability. It is free to define it as it sees fit. It chose to define it as close to be but 2% on the headline rate. It seems as arbitrary as the 3% deficit cap in the Maastricht Treaty and the in Stability and Growth Pact. It is true that households spend on food and energy. That is not the point. We are talking about setting policy. We are talking about maximizing the signal and minimizing the noise.
It is in the process of adopting more Federal Reserve like style, such as less frequent policy making meetings, rotating voting, and soon to release some record of the meeting (aka “minutes”). For its part, the Federal Reserve has adopted some features of the ECB, like press conferences. There is some interest in the Fed having more press conferences, but this is still being studied, I am told. The Federal Reserve has also formally adopted an inflation target, after eschewing it for the better part of a century.
As is well known, the Fed targets the core PCE deflator. Not CPI, and not the headline rate. Shouldn’t this be another area that the ECB takes a page from the Fed’s play book? A look at the ECB’s brief history suggests that targeting the core CPI would generate better policy signals. Targeting core CPI may have still led the ECB to pursue unorthodox measures to expand its balance sheet, but it would formally recognize that lower energy prices are not a reason to panic. The drop in oil prices appears to be already boosting eurozone consumption.
There is no doubt that there are many bright and capable economists at the ECB. Yet no one has made a compelling case that the ECB ought to target headline inflation instead of core. Even reporter have failed to press Draghi on this point. I have suggested ego and inertia on the main obstacles. Some have said my judgment was too harsh. I would be happy to be proven wrong. To this end, I offer a signed copy of my book, Making Sense of the Dollar, in which I anticipated the dollar’s bull market, to the reporter who asks Draghi about this.