Price stability

economic-dictionary

Price stability is the situation in which prices are maintained or grow at a certain level considered adequate for a certain time.

Price stability makes it possible to relax monetary policies to control inflation and credit expansion, so that there is more money in circulation and the economy can function better and jobs are created at a higher rate. Controlling inflation is necessary for Central Banks since 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 more and more expensive. When this happens, unless our salary increases as well, we could lose purchasing power. Since if our salary is maintained and prices rise we can buy less things. In addition, this does not only penalize immediately but also in the medium and long term. If we decide to save $ 100 today, it may be that in 10 years, if inflation is strong, that $ 100 will not even help us to buy products that are very cheap today.

For its part, deflation is not desirable either. At least in aggregate terms. In theory, the price drop is positive if it occurs in line with an improvement in technology. For example, new research makes it possible to produce crystals at a very low cost. Without a doubt, the price of glass will plummet and this is very positive. The problem is when prices fall due to insufficient demand. That is, when people do not have money to buy. This could happen in crisis settings.

Additionally, there is another explanation that is not empirically proven but is cited by central banks. This explanation is based on the fact that consumers, if they know that something will be cheaper tomorrow (deflation), will wait to buy it tomorrow and so on. This causes prices to plummet and with it activity. What central banks forget is that there are certain products where there is no point waiting. 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 in 3 years, of course we will not be able to use it for 3 years.

Price stability example.

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

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