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'''Price stability''' is a condition in which the general level of prices changes slowly and predictably, so that inflation is low and stable. It is the primary objective of many central banks and is widely regarded as a precondition for sustainable growth and employment.

== Definition and Measurement ==
Price stability is typically defined quantitatively. The European Central Bank aims for inflation of two per cent over the medium term, while the Federal Reserve targets two per cent on average. The precise target reflects the view that a small positive rate provides a buffer against deflation while avoiding the costs of high inflation.

Inflation is measured by indices of consumer prices, producer prices, or broader measures of the price level. Each index has limitations, including substitution bias, quality adjustment, and coverage. The choice of measure affects the assessment of whether stability has been achieved.

== Benefits of Price Stability ==
Price stability reduces uncertainty about future prices, facilitating long-term contracts, investment, and saving. It preserves the information content of prices, which is essential for the efficient allocation of resources. It reduces the arbitrary redistribution of wealth between debtors and creditors that inflation causes.

Price stability also avoids the costs of high and variable inflation, including the costs of holding money, the distortions of the tax system, and the erosion of the value of savings. It reduces the risk of inflation becoming entrenched in expectations, which makes it harder to control.

== Costs of Inflation ==
Even moderate inflation imposes costs. It acts as a tax on money holders, encouraging them to economise on cash. It interacts with the tax system, since nominal gains are taxed and nominal interest is deducted, distorting saving and investment. It creates uncertainty and shortens the horizons of contracts.

High inflation is associated with lower growth, greater inequality, and social instability. The relationship between inflation and growth appears to be nonlinear, with the adverse effects becoming pronounced at higher rates. This finding informs the choice of inflation targets and the assessment of the costs of moderate inflation.

== Achieving Price Stability ==
Central banks achieve price stability through the setting of policy rates and, when necessary, through unconventional measures. Credibility is crucial, since expectations determine the inflation that results from any given policy. Institutional arrangements, including central bank independence and clear mandates, support credibility.

Monetary policy alone cannot guarantee stability where fiscal policy is unsustainable or where structural problems generate inflation. Coordination with fiscal policy and attention to the sources of inflation are necessary for the achievement and maintenance of price stability.

== The Optimal Inflation Rate ==
The question of the optimal inflation rate remains debated. Proponents of low positive inflation argue that it provides a buffer against deflation and allows real wages to adjust without nominal cuts. Proponents of zero or negative inflation argue that it minimises the distortions of the tax system and the costs of holding money.

Estimates of the optimal rate vary, reflecting different assessments of the costs of inflation and deflation and of the constraints on policy. The choice of target also reflects institutional and political considerations, and the widespread adoption of two per cent targets reflects a pragmatic compromise rather than a precise calculation.

== Credibility and Expectations ==
The achievement of price stability depends crucially on expectations. If the public believes that the central bank will maintain low inflation, then inflation expectations remain anchored, and the central bank can achieve its target with smaller movements in interest rates. If expectations become unanchored, the task becomes harder.

The anchoring of expectations depends on the credibility of the central bank, which in turn depends on its track record, its mandate, and its independence. Communication, transparency, and the consistent pursuit of the target all contribute to credibility, and their importance has grown as central banks have become more transparent.

== Deflation and Its Risks ==
Price stability protects against the risks of deflation, a sustained decline in the general price level. Deflation raises the real burden of debt, discourages spending as consumers postpone purchases, and can interact with the zero lower bound to make monetary policy ineffective. The experience of Japan and of the Great Depression illustrates the costs of deflation.

The risk of deflation motivates a positive inflation target, since a buffer above zero reduces the likelihood that the economy will fall into deflation when demand is weak. The buffer also allows real interest rates to fall to negative levels, providing room for monetary policy to respond to downturns.

== International Dimensions ==
Price stability is a domestic objective, but it has international dimensions. Inflation differentials among countries affect competitiveness and trade balances, and exchange rate movements can transmit inflation across borders. For countries in a currency union, the common monetary policy must balance conditions across members, which may have different inflation rates and different cyclical positions.

Coordination among central banks, through forums and through the exchange of information, contributes to the stability of the international monetary system. The recognition of spillovers and of the benefits of cooperation informs the design of international arrangements and the analysis of global inflation dynamics.

== See also ==
* [[Inflation]]
* [[Central banking]]
* [[Monetary economics]]

== References ==

<ref name="r1">Central bank publications on monetary policy and price stability.</ref>
<ref name="r2">Research on the costs of inflation and the benefits of stability.</ref>
<ref name="r3">Studies of inflation targeting and central bank credibility.</ref>

<references />

[[Category:Monetary economics]]
[[Category:Central banking]]
[[Category:Inflation]]