Is price stability all what it cracked up to be?

After the 1970’s and 1980’s where inflation was allowed to spiral out of control in nations such as the UK and in particular the USA (where inflation levels were often in double digits) a controlled low inflation rate has often been seen as crucial to economic stability. Due to this, everyone appears keen to take credit for it, with policymakers and bankers being common claimants. However, is price stability really that important?

Stephen D. King, chief economist of HSBC believes this not to be the case claiming that;

“The blinkered pursuit of low inflation in the west has been a mistake, leading to asset price bubbles, economic booms and busts and excessive accumulation of debt”

This is an intriguing argument and one that needs to be looked at. Whilst controlling inflation helps to enable stable employment with price volatility not effecting prices and wages, its actual relationship with the economy isn’t as stable as one would imagine. With central bankers being perhaps the keenest advocates of controlled inflation they often control short term interest rates in order to meet broader economic aims. This however, isn’t wholly healthy for the economy as it plays upon people’s fears.

For example were interest rates to increase people may fear that more austere times are upcoming and as such be less willing to spend and will have an increased penchant to save. A fall in interest rates meanwhile may lead to a rise in demand for housing due to lower mortgage rates. Whilst both a fall or rise in interest rates will effect the attractiveness of a nation for foreign investment with the latter making it more attractive and as a result leading to a rise in inward investment.

The deutschmark was rendered useless due to inflation

Controlling inflation rates therefore may well appear to help economic stability, and in some sense it does as the value of money is sustained without there being any volatile changes. However, the opportunity cost means that the control of interest rates to help insure the low inflation rates can often lead to negative repercussions such as reduced consumer spending and a decline in the competitiveness of a countries exports. Thus showing that price stability won’t always ensure economic stability.

Answers to quiz: 1-A, 2-B, 3-A, 4-B, 5-C