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Our price stability objective and the strategy review

Our job is to keep prices stable. The economy has changed a lot since 2003, when we last carried out a strategy review. We want to ensure that our price stability objective remains clear, predictable and easily understood in this changing economic landscape. That is why the Governing Council has agreed on an inflation target of 2% over the medium term.

Why was our price stability objective part of our strategy review?

Stable prices are good for the economy

We all care about how much the things we buy cost, especially if prices change a lot or in an unpredictable way. Our economy works best when prices overall are stable. Stable prices allow money to keep its value, and they help people and businesses better plan their spending and investment. That helps the economy to grow, in turn creating jobs and prosperity.

Our job is to maintain price stability

We do this by making sure that inflation – the rate at which the overall prices for goods and services change over time – remains low, stable and predictable.

Why did we review our goal?

A new economic landscape …

Today’s economic landscape is very different from the one back in 2003. Instead of preventing inflation from rising too high, we must now keep it from falling too low. There are many reasons why inflation has fallen in recent years. They relate to the way our economies work, and these developments are not all under the control of central banks.

…calls for a new inflation target

For us, it is clear that price stability means guarding against inflation that is either too low or too high. That is why we are targeting an inflation rate of 2% over the medium term. Our commitment to this inflation target is symmetric. That means we view inflation that is too low just as negatively as inflation that is too high. Both are equally undesirable.

Why is too low an inflation rate a bad thing?

Inflation that is too low is not as good as you might think

Price increases should be small enough so as not to create the problems that come with high inflation for people and businesses. But they should be large enough to avoid bad scenarios that may unfold if inflation falls too low. Inflation that is too low often means people spending less on goods and services, companies being less successful and workers getting smaller pay rises.

The risk of deflation

When the economy shrinks, inflation tends to fall. But if inflation is already too low when a recession hits, we could start to see inflation falling below zero. If prices are falling continuously across the board – a phenomenon called “deflation” – it creates a vicious circle for the economy. For instance, if we all expect prices to fall, we tend to postpone today’s purchases to take advantage of lower prices tomorrow. And if everybody did this, the economy could grind to a halt. By targeting an inflation rate of 2% over the medium term, we can create a safety buffer to avoid this scenario.

Making sure our inflation target is easily understood

A clear inflation target can better influence expectations

Inflation that is too low for too long can influence how people expect prices to develop in the future. If shoppers and business owners get used to very low inflation, they come to expect that it will stay that way. These expectations are important. People use them to make decisions about spending, borrowing and investing.

That is why our inflation target needs to be clear, predictable and easily understood. It helps people expect future price changes to be around the level we are aiming for. That in turn helps us keep prices stable.

If these expectations were to move far below our target, it would become very difficult for us to steer the actual development of prices in the economy back to that target. By keeping inflation close to our target, we can help avoid people forming such expectations.

STRATEGY REVIEW
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