Definition and meaning

Inflation, in economics, indicates a generalised and continuous increase in prices over time. It is a fundamental indicator because the price level conditions the purchasing power of households, the general performance of the economy and the orientation of the central banks’ monetary policies.

How it is calculated

To calculate inflation it is necessary to construct a consumer price index and in most countries the measurement of this index is assigned to the National Institute of Statistics. In Italy, therefore, ISTAT takes care of it and, on the basis of the prices of a set, called basket, of goods and services, representative of household consumption, calculates its consumer price index. In the Istat consumer price basket there are, for example, with different relative weights, the prices of clothing and footwear, foodstuffs, health services, transport, electricity, water and so on.

In particular, ISTAT compiles three main consumer price indices:

• The National Consumer Price Index for the Whole Community (Nic) which measures the change over time in the prices of goods and services purchased on the market for individual final consumption;
• The consumer price index for blue-collar and white-collar households (Foi): calculates the change over time in retail prices, of goods and services currently purchased by employed households;
• The Harmonised Index of Consumer Prices (HICP) developed to ensure a comparable measure of inflation at the European level. Unlike the Nic and Foi indices, the HICP index refers to the price actually paid by the consumer and excludes some items in the basket of the other two indices while also taking into account temporary price reductions (such as sales, discounts and promotions).

Inflation, interest rates and monetary policy

It is important to point out that the European Harmonised Index HICP (or HICP) is of great relevance because it is used as an indicator to check the convergence of the economies of the member countries of the EU (European Union), for the purpose of permanence or entry into the Monetary Union. The HICP index is also used as a reference by the European Central Bank (ECB) for the implementation of European monetary policy. As is well known, the ECB’s main objective is to maintain price stability in the Eurozone.

Inflation, interest rates and monetary policy

It is important to point out that the European Harmonised Index HICP (or HICP) is of great relevance because it is used as an indicator to check the convergence of the economies of the EU (European Union) member countries, with a view to permanence or entry into the Monetary Union. The HICP index is also used as a reference by the European Central Bank (ECB) for the implementation of European monetary policy. As is well known, the main objective of the ECB is to maintain price stability in the Eurozone.

In fact, price stability is considered one of the basic conditions for raising the level of economic activity and employment. Rapidly rising (‘galloping’) inflation can in fact erode the purchasing power of households, effectively impoverishing them. Conversely, deflation, i.e. negative inflation with falling prices, can bring the economy to a standstill because - to put it simply - firms’ selling prices do not cover their production costs and send them into crisis. In any case, too high or too low levels of inflation frighten investors and damage confidence, adversely affecting economic activity. For these reasons, central banks set inflation targets to which they anchor their monetary policy, i.e. conventional main interest rate interventions or unconventional interventions such as quantitative easing. The ECB’s goal is to bring inflation to a level close to but below 2 per cent, although in recent years a ‘symmetrical approach’ has been promoted whereby the target can be reached from either the bottom or the top (in other words, there is no ceiling on 2 per cent, but price deviations can occur in one direction or the other). This price level is considered by most of the world’s central banks to be optimal in order to secure the various players in the economic environment.

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