Theory Of Economic Cycle

What are the Benefits of Price stability :

The objective of price stability refers to the general level of prices in the economy.

• It implies avoiding both prolonged inflation and deflation.
  
  
• Price stability contributes to achieving high levels of economic activity and employment by improving the transparency of the price mechanism. Under price stability people can recognize changes in relative prices (i.e. prices between different goods), without being confused by changes in the overall price level. This allows them to make well-informed consumption and investment decisions and to allocate resources more efficiently;
  
  
• Reducing inflation risk premia in interest rates (i.e. compensation creditors ask for the risks associated with holding nominal assets). This reduces real interest rates and increases incentives to invest;
  
  
• avoiding unproductive activities to hedge against the negative impact of inflation or deflation;
  
  
• reducing distortions of inflation or deflation, which can exacerbate the distortionary impact on economic behavior of tax and social security systems;
  
  
• preventing an arbitrary redistribution of wealth and income as a result of unexpected inflation or deflation.

The ECB’s Governing Council has announced a quantitative definition of price stability:

"Price stability is defined as a year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below 2%." The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term.

By referring to “an increase in the HICP of below 2%” the definition makes clear that not only inflation above 2% but also deflation (i.e. price level declines) is inconsistent with price stability.
Reasons for aiming at below, but close to, 2% Inflation rates of below, but close to, 2% are low enough for the economy to fully reap the benefits of price stability.

Price Stability is the primary objective of all economies globally:

Economies Globally target 0% to 2% inflation to achieve price stability and it is well accepted norm globally to archive the above mention benefits.