Price stability

Price stability
See also

Price stability'- the state of the financial system, covering all financial markets and the infrastructure supporting them, in which it performs its functions in a continuous and effective manner, even in the event of unexpected and adverse disturbances of a significant scale

Functions of price stability

Maintaining the stability of the financial system is a prerequisite for sustainable economic growth, and the condition of the banking sector is in the spotlight, as it plays a key role in the national financial system. An inseparable part of the above definitions are the functions of the financial system. J.G. Schinasi distinguishes the following functions of the financial system:

  • 'effective and efficient allocation' of financial resources (between entities managing accruals), i.e. the process of financial intermediation,
  • 'correct valuation', allocation and financial risk management.

The above classification emphasizes the importance of the financial intermediation function through which a stable financial system supports economic development. An important function of the financial system is also the payment function, which concerns ensuring smooth flow and access to money. It depends, among others on the security and efficiency of the payment system supervised by the central bank, and its disturbance may negatively affect confidence in money. The functions fulfilled by the financial system can therefore be associated with the functions fulfilled in the economy by money, and in particular with the payment, circulation, value measure and thesaurizing function.

Benefits od proce stability

The price stability objective refers to the general price level in the economy. This means avoiding both long-term inflation and deflation. Price stability contributes to achieving a high level of economic activity and employment through:

  • to improve the transparency of the price mechanism. In terms of price stability, people can recognize changes in relative prices (i.e. Prices between different goods), without confusing changes in the general price level. This allows them to make informed decisions on consumption and investment, and effectively allocate resources;
  • avoiding unproductive measures to safeguard against the negative effects of inflation or deflation;
  • lowering the inflation risk premium in interest rates (i.e., creditors are asking for compensation for the risk associated with owning nominal assets). This reduces real interest rates and increases the incentives to invest;
  • arbitrary redistribution of wealth and income as a result of unexpected inflation or deflation;
  • limiting distortions of inflation or deflation that may exacerbate the disruptive effect on the economic behavior of tax and social security systems prevention;
  • contributing to financial stability.

Although the Treaty explicitly establishes price stability as the main objective of the ECB, it does not specify what is meant by price stability.

Quantitative definition of price stability

The Governing Council of the ECB has defined price stability as the annual increase of the harmonized index of consumer prices (HICP) for the euro area below 2%. Price stability should be maintained in the medium term. The Governing Council also explained that, striving for price stability, it aims to keep inflation below, but close to, 2% over the medium term.

References

Author: Martyna Sołtys