Price Stability

Article byGayatri Ailani
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Price Stability?

Price stability occurs when there is an absence of large swings in the general level of prices in the economy. Maintaining price stability entails avoiding lengthy phase of inflation or deflation that are too high, contributes to high employment, and moderate long-term interest rates. 

Price Stability

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Understanding the importance of stable prices is one of the most crucial elements of a growing economy. Making decisions about pricing and purchasing becomes challenging when there are large fluctuations in price levels. On the other hand, when the price of goods and services is stable, inflation is under control in the economy. Low and stable inflation and its low expectancies enhance economic growth and stability.

Key Takeaways

  • Price stability definition in economics explains it as the stability in the general level of prices in the economy. The scenario contributes to high employment and moderate long-term interest rates.
  • It is essential for the market economy’s long-term growth and efficient functioning.  
  • High inflation and deflation negatively impact a country’s economic performance and general well-being. Maintaining price stability entails avoiding lengthy phases of inflation or deflation that are too high.
  • Utilizing fiscal or monetary policy tools is the primary way to maintain price stability in the economy and ensure stable economic growth. 

Price Stability Explained

Price stability is when the average price levels are constant for more extended period and vary slowly. It is significant for the market economy‘s long-term growth and efficient functioning. Price deflation arises when average prices decline, while price inflation occurs when average prices rise above the standard and estimated level. Both scenarios influence a nation’s economic performance and the well-being of the people.

The absence of price stability can create various issues. For example, consumers’ purchasing power decreases as prices rise sharply during inflation. In contrast, during deflation, when prices decrease sharply, the purchasing power of currency increases. However, production may decrease when prices decline. Moreover, wage cuts might result from the diminished output, and demand may decline due to lower compensation. Additionally, the decline in demand may result in prices falling further.

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Examples

Let us look at price stability examples to understand the concept better :

Example #1

During low or no inflation, generally, it is observable that the prices of groceries are stable between years. The price difference between years and the change percentage will be more minor. Such an environment indicates price stability. At the same time, during high inflation, groceries are substantially more costly to purchase compared to the period of low inflation. The cost of groceries keeps rising, and it looks like it will stay that way. The price of vegetables, fresh fruits, pre-packaged cereals, baked goods, meat, poultry, fish, and eggs rises. 

Example #2

Maintaining price stability to preserve the euro’s purchasing power is the European Central Bank’s (ECB’s) primary objective. In 1998, ECB Governing Council provided the quantitative definition of price stability- “Price stability shall be defined as a year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below 2%. Furthermore, price stability is to be maintained over the medium term.

For the European Central Bank, Harmonised Index of Consumer Prices (HICP) measures inflation and price stability (ECB). It is a consumer price index that is calculated using a technique that has been standardized throughout EU member states. As a result, a weighted average of price indices from member countries that have accepted the euro makes up the HICP for the euro region.

Price Stability And Economic Growth

The fiscal policy adopted by the government or central bank monetary policy favoring the economic growth and welfare of the general public are also options for contributing to price stability. For example, to change the money supply in the economy, governments can alter government spending and tax rates depending on different situations.

In other words, fiscal policies effectively control inflation and deflation. Likewise, central banks like the U.S. Federal Reserve can adjust lending interest rates to combat inflation. Altogether, the policies from governing entities can create or maintain price stability and economic growth. 

Advantages & Disadvantages

The price stability advantages are as follows: 

  • The quality, integrity, and purchasing power of the national currency are protected via price stability. 
  • It is monetary policy’s ultimate objective or sometimes a transitional one because stable prices lead to increased economic growth and stability.
  • It fosters efficiency and long-term prosperity by creating an economic and economic environment in which markets can function and economic decisions can be taken without fearing unforeseen changes in the purchasing power of money.
  • People may keep the money for transactions and other uses when prices are steady without fearing that inflation would reduce the real worth of their money reserves.

The price stability disadvantages are as follows: 

  • According to some economists, it is a romantic concept on its best day that would stifle innovation and lead to lower living standards.
  • A stable price level can lessen businesses’ motivation to expand their supply. For instance, if supply constraints are causing prices to rise. Price increases will encourage businesses to expand their supply. However, this incentive to boost supply is diminished if the government pursues price regulations. As a result, price limitations can potentially prolong the shortage rather than resolve it.
  • It can create a condition of black marketing, specifically in the presence of price ceiling measures. Furthermore, there will be a temptation to buy at artificially low prices and sell on the black market for a more fantastic price.

Frequently Asked Questions (FAQs)

Why is price stability important?

The purchasing power of the country’s currency is maintained via price stability. People don’t have to worry about inflation when prices are steady, allowing them to hold money for various other uses. The stable price conditions help individuals make better investment decisions in the long run. The lowest price and interest rates fluctuations make it easier for people to buy goods and services or consume according to stable prices. 

How to maintain price stability?

Fiscal and monetary policy can be directed to ensure stable prices. For example, the government can change and manage spending and tax policies to influence the prices and monetary policies by the central bank controlling money supply and interest rates, subsequently contributing to stable prices and economic growth. 

​ What affects price stability?

In a free market, supply and demand determine price levels. Therefore, changes in supply and demand can cause changes in the normal price level. However, an economy’s financial stability is in danger when significant variations in overall price levels exist. For this reason, governments and banks try to control prices.

This article has been a guide to what is Price Stability. We explain its definition in economics, examples, advantages, and disadvantages. You may also find some useful articles here –

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Comments

  1. Abenet says

    Good concept I got from the article

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