What are the negative aspects of inflation

Why are stable prices important?

What speaks against high inflation?

High inflation can trigger a spiral of rising prices. This reduces the purchasing power of your money. So you can buy less with it.

If the prices of many of the products you buy go up, your purchasing power will decrease. In other words, you can buy less from your money, from your income and savings, than you did before. This can trigger a spiral of rising prices.

The reason for this is as follows: If everything is getting more and more expensive, you might ask your employer about a raise. As a result, your employer may raise the prices for the company's products in order to finance the higher salaries of the employees. If this happens in many companies, the prices of numerous products continue to rise. The spiral of rising prices continues.

This makes it more difficult for you and for companies to make savings and investment decisions. Confidence in the currency may be dwindling among the population because it rapidly depreciates. These are just a few examples of the adverse side effects of high inflation rates.

What speaks against prolonged deflation?

Persistent deflationary phases can lead to a spiral of falling prices. This can have negative consequences for businesses and consumers and can be reflected in public spending.

Lower prices may sound good to you as a consumer at first. But if prices fall permanently and across the board, without this being due to improvements in production, then that is a problem. Because then there is a threat of a spiral of falling prices.

For example, if you are planning to buy a new sofa and you already know today that the sofa will be cheaper at a later date, then you will probably wait and see. If all consumers think this way, it will have a negative impact on companies because they will then no longer be able to sell their products. Due to falling demand, companies may be forced to cut salaries, forego raising salaries, or even have to lay off staff.

Economic growth would slow as consumers and businesses cut back on spending and investment. It may also make it more difficult to manage debts, e.g. B. real estate loans to repay. Because your debts are not decreasing, but your income may be.

The same goes for the public budget. With falling incomes and lower consumer spending, tax revenues also decline. The state still has to pay off its debts. As a result, the state may cut its spending on e.g. B. Infrastructure and Healthcare. So each and every one of us is feeling the negative effects of deflation.

Price stability in numbers

Why below but close to 2%?

Why is the ECB's medium-term inflation target “below but close to 2%” and not 0% or 1%? There are mutliple reasons for this:

Inflation measurement buffer

This buffer takes into account the fact that inflation rates could be set a little too high.

This margin offers a certain safety buffer against potential deflation risks.

Differences between countries

The target value leaves room for inflation differentials between the countries of the euro area.

To deepen:

Inflation measurement buffer

The method of calculating the inflation rate (as measured by the HICP index) can result in the inflation rate being overstated. This could e.g. This could be the case, for example, when a product in the shopping cart that is used to calculate the index becomes more expensive due to its higher quality. For example, a car could be better equipped in terms of safety than its predecessor. When calculating inflation, it is necessary to sufficiently take into account the reason for the change in price, namely the improvement in the product. Otherwise, the inflation rate is assumed to be higher than it actually is.

Margin of safety

The inflation target of below but close to 2% offers a certain margin of safety against potential deflation risks. In the event of deflation, traditional monetary policy instruments (i.e. changes in key interest rates) reach their limits. At a certain point, further interest rate cuts are no longer a sensible option for a central bank. In addition, even controlled inflation tends to move around an average value over time. By including a buffer above zero, the central bank has to resort to unconventional measures such as quantitative easing (QE) or longer-term refinancing operations less often.

Differences between the countries of the euro area

The ECB ensures price stability throughout the euro area. With an inflation target below, but close to, 2%, there is scope for differences between the inflation rates of the countries in the euro area. Ideally, however, these balance out over time. An inflation target above zero can prevent some countries or regions from having to bear very low or even negative inflation rates in order to offset the higher inflation rates of other countries.