The “Price Stability” Myth Undermines Our Economy and Well-Being

For most commentators, a "stable price level" is seen as essential for economic stability. When consumer demand increases for one product over another, such as potatoes compared to tomatoes, the price of the favored product, potatoes, rises. Businesses need to be aware of these changes to avoid losses and make informed production decisions based on relative price changes. Economists argue that without a stable price level, it becomes difficult for businesses to understand demand shifts and make appropriate choices, leading to misallocation of resources and weakening economic fundamentals. Therefore, central banks are tasked with achieving "price stability" to help businesses recognize relative price changes.

Central banks, like the Federal Reserve, aim to keep inflation at around 2% each year, believing that any significant departure from this rate signifies instability. This belief is rooted in the idea that money is neutralalterations in the money supply only affect the overall price level, not relative prices among goods and services. For example, if the price of apples and potatoes is set, introducing money does not change their relative pricing; it simply allows for easy transactions in dollars.

If money supply doubles and prices double, a seller can still use the dollar amount they receive to buy the same amount of goods. However, this assumption is problematic. When new money is introduced, the first recipients benefit while others may not as prices begin to rise unevenly throughout the economy. Those who receive money later face rising prices and may be able to afford less, highlighting that increases in the money supply lead to a redistribution of wealth and alter demand for various goods.

The new dynamics from inflationary money supply increases cannot be sustained without ongoing growth in the supply, creating an unsustainable economic structure. The Federal Reserve’s policies to stabilize the price level involve increasing the money supply, which disrupts the natural allocation of resources since money injections are not neutral.

Prices are influenced by both real and monetary elements, meaning that sometimes, even with strong money growth, prices may not rise as expected. This can mislead economists into believing that price stability implies a healthy economy. Historically, such oversights have caused economists to miss signs of potential economic downturns. The idea of establishing a general "price level" is also flawed, as it is not possible to meaningfully determine a singular purchasing power of money in transactions across diverse goods without recognizing their unique values.

In conclusion, while many believe that "price stability" is crucial for economic well-being and efficient resource use, the Federal Reserve's pursuit of this stability through monetary policy undermines economic fundamentals. Instead of enforcing price stability, allowing free market fluctuations and maintaining sound money would enable businesses to respond accurately to consumer demands. 

https://mises.org/mises-wire/price-stability-myth-undermines-our-economy-and-well-being