Benefits of price stability

Our economy works best when there is price stability. That means we need to guard against an inflation rate – the rate at which the overall prices for goods and services change over time – that is either too low or too high. Price increases should be small enough not to create the problems that come with high inflation for people and businesses. But they should be large enough to avoid bad scenarios that may unfold if inflation falls too low. When inflation is low, stable and predictable, it helps people and businesses to better plan their savings, spending and investment. That helps the economy to grow, in turn creating jobs and prosperity.

Price stability has the following benefits.

• It allows us to avoid the inefficiency costs arising from the presence of nominal rigidities.
• It reduces the inefficiency costs created by inflation being a tax on money balances.
• It avoids adverse redistributive effects of inflation. The adverse effect of inflation on income and wealth differs across different cohorts of society, with higher inflation especially detrimental for low-income households with limited investment options.
• It avoids adverse interactions of inflation with taxation. The presence of inflation creates distortions because taxes are levied in nominal terms and there is no full indexation. For instance, if your nominal income grows in line with inflation but the tax brackets are not updated in line with inflation, you end up paying more taxes even if your inflation-adjusted income has not changed. By keeping inflation low and stable this effect is reduced.
• It reduces unexpected changes in inflation, which create distortions. For example, if there is an unanticipated increase in inflation, the value of savings goes down and the value of debt goes down, which transfers wealth from savers to borrowers.
• It decreases the volatility of inflation, which in turn lowers uncertainty and market interest rates and this motivates people to invest.
• It contributes to a more stable financial system.
• It helps to maintain social cohesion and stability. History has shown that episodes of high inflation as well as episodes of deflation, or persistently falling prices, tend to be associated with social unrest. Unstable inflation particularly affects low-income households because they have fewer resources to protect themselves. When prices are stable, everyone is better off: price stability supports economic growth and employment, and allows people to make more reliable plans when taking decisions about borrowing, saving, and expanding businesses.

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