Price stability

Price stability is that situation in which prices remain or grow at a certain level considered adequate for a certain time.

Price stability allows monetary policies to control inflation and credit expansion to be relaxed , so that there is more money in circulation and the economy can function better and employment is created at a higher rate. Inflation control is necessary for Central Banks as it can cause a rise in nominal interest rates, increasing the opportunity cost of having money.

Why do central banks want a moderate level of inflation?

Both inflation and deflation, if produced in excess, are negative. It is with this objective that central banks try to keep prices stable. Or put another way, they pursue price stability.

If inflation occurs in an excessive amount, what happens is that the products are increasingly expensive. When this happens, unless our salary increases too, we could lose purchasing power. Since if our salary is maintained and prices go up we can buy fewer things. In addition, this does not penalize only immediately but also in the medium and long term. If we decide to save 100 dollars today, maybe in 10 years, if inflation is strong, those 100 dollars do not even help us to buy products that are very cheap today.

On the other hand, deflation is not desirable either. At least in aggregate terms. In theory, the price drop is positive if it occurs according to an improvement in technology. For example, new research allows crystals to be produced at a very low cost. Without a doubt, the price of the glass will plummet and this is very positive. The problem is when prices fall due to insufficient demand. That is, when people have no money to buy. This could happen in crisis environments.

Additionally there is another explanation not empirically proven but cited by central banks. This explanation is based on the fact that consumers, if they know that tomorrow something will be cheaper (deflation), will wait to buy it tomorrow and so on. This makes prices plummet and with it the activity. What central banks forget is that there are certain products that make no sense to wait. And, on the other hand, is that the opportunity cost of not having a product, sometimes does not compensate with the price drop that it will have. For example, a car may be 5,000 euros cheaper within 3 years, of course we cannot use it for 3 years.

Example of price stability.

For example, suppose a person who has a monthly salary of 1,400 euros net, with whom he buys a certain number of goods and services for consumption. It is said that the general level of prices is stable if during the next few years this person can buy the same set (or similar) of goods and services with the same salary.

 

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