Price stability

Why is it important for you?

Given the widespread recognition of the benefits of price stability, it is important that everyone, and young people in particular, understands the importance of price stability, how it can best be achieved, and how maintaining stable prices supports the broader economic goals of the European Union. This book consists of various chapters: each of them contains basic information and can be referred to individually, as and when required. The degree of complexity is, however, higher in Chapters 4 and 5 than in the first few chapters. In order to understand fully Chapter 5, it is necessary to have read Chapter 3 and, in particular, Chapter 4 carefully. Additional boxes are provided to address some specific issues in more detail.

The benefits of price stability, or the costs associated with inflation or deflation, are closely linked to money and its functions. Chapter 2 is therefore devoted to the functions and history of money. The chapter explains that in a world without money, i.e. in a barter economy, the transaction costs associated with the exchange of goods and services are very high. It also illustrates that money helps to achieve a more efficient exchange of goods and thereby enhances the welfare of consumers. These considerations are followed by a more detailed discussion of the role and the basic functions of money in Section 2.1.The forms of money used in societies have changed over time. The main historical developments are briefly reviewed and explained in Section 2.2.

Chapter 3 explains the importance of price stability. It first defines the concepts of inflation and deflation (Section 3.1). After a short section illustrating some measurement issues (Section 3.2), the next section describes the benefits of price stability and, conversely, the negative consequences of inflation (or deflation) in detail (Section 3.3).

Chapter 4 focuses on the factors determining price developments. Beginning with a brief overview (Section 4.1), it proceeds to investigate the influence of monetary policy on interest rates (Section 4.2). Subsequently the effects of interest rate changes on expenditure decisions by households and firms (Section 4.3) are illustrated. In the next section, the factors driving the inflationary process over the shorter term are reviewed (Section 4.4). Particular emphasis is placed on the fact that monetary policy alone does not control short- term price developments, as a number of other economic factors can have an impact on inflation within this timescale. However, it is acknowledged that monetary policy controls inflation over the longer term (Section 4.5).

The closing chapter contains a short description of the ECB’s monetary policy. Following a closer look at the process leading to Economic and Monetary Union (Section 5.1), the subsequent sections deal with the institutional framework of the single monetary policy (Section 5.2), the ECB’s monetary policy strategy (Section 5.3) and the Eurosystem’s operational framework (Section 5.4).


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