Price Stabilization

Price stabilization is the use of policy to reduce fluctuations in the prices of goods, of assets, or of the general price level. Price stabilization is a central objective of economic policy, and it is pursued through a range of instruments.

Objectives

The objective of price stabilization is to reduce the uncertainty and the costs associated with price fluctuations. Fluctuations in prices create uncertainty for firms and households, complicate planning, and can distort the allocation of resources.

The stabilization of the general price level is the objective of monetary policy, which seeks to keep inflation low and stable. The stabilization of particular prices is the objective of sectoral policies, which seek to reduce fluctuations in the prices of commodities and of other goods.

Instruments

The instruments of price stabilization include monetary policy, which affects the general price level through its effect on demand. The central bank adjusts the policy rate and other instruments to keep inflation close to its target.

The instruments include fiscal policy, which affects prices through its effect on demand and through the taxes and subsidies that it imposes. The instruments include buffer stocks, in which the authority buys and sells the commodity to stabilise its price.

The instruments include price controls, which set the prices of particular goods. The controls are used to protect consumers and to reduce inflation, though they can create shortages and distortions.

Commodity Price Stabilization

The stabilization of commodity prices is a particular concern for developing countries, which depend on the export of commodities. The prices of commodities are volatile, and the fluctuations affect the incomes of producers and the revenues of governments.

The instruments for stabilizing commodity prices include buffer stocks, export taxes, and stabilization funds. The funds accumulate revenue during periods of high prices and disburse it during periods of low prices, smoothing the effect on the budget and on the economy.

The experience with commodity price stabilization has been mixed. The buffer stocks have often been expensive to maintain and have been subject to the risk that the price will move against the authority. The stabilization funds have been more successful, though their effectiveness depends on the design and on the discipline of the management.

Debate

The debate about price stabilization concerns the appropriate balance between the benefits of stability and the costs of intervention. Some argue that the authorities should focus on the stability of the general price level and allow particular prices to adjust, while others argue that the stabilization of particular prices is important for the welfare of producers and consumers.

The debate also concerns the effectiveness of the instruments. The experience with price controls suggests that they are difficult to sustain and that they can create distortions, while the experience with monetary policy suggests that it is effective in stabilizing the general price level.

Monetary Policy and Price Stability

The stabilization of the general price level is the objective of monetary policy in most countries. The central bank targets the rate of inflation and adjusts the instruments of the policy to keep the rate close to the target.

The framework of inflation targeting has been adopted by many central banks, and it involves the publication of the target and the communication of the policy decisions. The framework anchors the expectations of the public and improves the credibility of the policy.

The central bank uses the policy rate, and in the periods of the stress it uses the unconventional instruments, including the asset purchases and the forward guidance. The effectiveness of the framework depends on the credibility of the central bank and on the transparency of its decisions.

Buffer Stocks

The stabilization of the commodity prices is pursued through the buffer stocks, in which the authority buys the commodity when the price is low and sells it when the price is high. The objective is to keep the price within a range and to reduce the fluctuations.

The experience with the buffer stocks has been mixed. The stocks have been expensive to maintain, and the authority has been exposed to the risk that the price will move against it. The international commodity agreements that used the buffer stocks were largely abandoned.

The alternative approach is the use of the stabilization funds, which accumulate the revenue during the periods of the high prices and disburse it during the periods of the low prices. The funds smooth the effect on the budget and on the economy, and they have been more successful than the buffer stocks.

The Costs of the Inflation

The analysis of the price stabilization is informed by the assessment of the costs of the inflation. The costs include the erosion of the real value of the money holdings, the distortion of the relative prices, and the redistribution of the wealth between the debtors and the creditors.

The costs are larger when the inflation is high and volatile, since the uncertainty complicates the planning and the contracts. The costs are smaller when the inflation is low and stable, which is the objective of the policy.

The assessment of the costs informs the choice of the target and the design of the framework. The benefit of the stabilization is the reduction of the costs, and the design must balance the benefit against the costs of the policy itself.

Summary

Price stabilization is the use of the policy to reduce the fluctuations in the prices, and it is pursued through the monetary policy and through the sectoral policies. The analysis of the instruments and of the costs of the inflation informs the design of the policy.

See also

• Monetary Economics
• Inflation
• Central Banking