Deflation and the eurozone GDP deflator

by George Hatjoullis

The debate continues and the ECB seems unconcerned. There have been attempts to ‘place the low inflation in context’ (i.e. dismiss it) by focusing on the contribution of lower oil and gas prices, from exalted levels, to the measured Harmonised CPI (HICP) for the eurozone. There is some merit. Disinflation that results from lower import costs is directly beneficial to the eurozone. The eurozone is a net importer of oil and gas based products. Lower oil and gas prices leaves more foreign currency to spend on other goods. It is thus a boost to domestic incomes and not directly a cause for concern. One wonders why the HICP is the focus of the debate on the extent of domestic price pressure.

Deflation is an issue for the domestic or internal eurozone economy. It is of relevance to GDP produced within this economic area. If residents of this area expect falling prices they will be predisposed to hold cash and deposits and this will have a depressing effect on domestic spending and production. If one is to look for evidence of deflationary, rather than disinflationary, pressure within the eurozone one should look at the GDP price deflator and not the HICP. GDP measures output within an economic region irrespective of the jurisdiction of ownership (hence domestic product). The GDP price deflator measures the weighted average cost of this output. If the GDP price deflator is falling then there is measured deflation and it is domestic. It implies domestic producers have little pricing power.

One problem with the GDP deflator is that it is calculated quarterly and the HICP is calculated monthly, so the focus naturally falls on the more frequently calculated measure. However, this does not make the HICP the most relevant measure with respect to deflation. The HICP measures the cost of a basket of consumer goods. This will include imports. The most useful measure with respect to domestic deflation pressure will focus on spending on domestically produced goods; this is the GDP deflator. The latest data for the GDP deflator is Q4 2013. The deflator index stood at 125.8 for the 18 eurozone countries. The data for Q3 2013 were 125.6. The GDP deflator grew by an annualised rate of 0.64% over these two quarters. The data for Q4 2012 were 124.4. The year-on-year change was 1.13%. There is evidently not much price pressure within the domestic eurozone economy and it has nothing to do with oil and gas prices or any other import costs. The release of Q1 2014 GDP price deflator should be awaited with interest and some concern.

The EU GDP deflator data are available here (