Why do we want low and stable inflation?
Both rapidly rising and falling prices can pose challenges to the economy. The best course of action is therefore to aim for something in between.
If you have a 100-krone note in your wallet or in the bank, it is an advantage to know roughly what you can buy with that amount in the foreseeable future. It will then be easier to plan consumption, investment and saving.
When prices rise
But if you fear that the value of your 100-krone note will fall rapidly, it will be more difficult to plan. Is there any point in saving your money, or should you hurry and spend it straight away? Are some things smarter to buy than other things?
When inflation is high, it also tends to be more variable. Large price variations can amplify economic fluctuations because households and firms become uncertain about their future income and expenditure and make substantial changes to their ongoing priorities.
Some countries have experienced what is referred to as hyperinflation, which is when prices rise and the value of money falls extremely quickly. In some cases, people have lost faith that their money will have any value at all in the future, which can be totally destructive for an economy and a very difficult problem to solve.
When prices fall
If prices start to fall, the value of our money rises. With a persistent fall in the general price level, also referred to as deflation, it immediately becomes more interesting to hold on to your money. If you wait, you will perhaps be able to buy much more for the same amount of money in the future.
If many people postpone consumption and investment, this could amplify a downturn in the economy. Such a situation can also be very difficult to remedy.
The golden middle course
The best scenario is if the price level lies somewhere in the middle – a reasonable distance away from negative inflation and too-high inflation. Some rise in prices may be beneficial for the functioning of the economy. As the demand for a commodity or occupational group increases, it will often contribute to the price of the commodity or wage of this occupational group increasing. The development in prices and wages can thus give a signal of what is demanded of goods and labor. In other words, we want inflation to be low and stable.
In Norges Bank’s objectives for monetary policy, the Government has defined low and stable inflation at 2 percent per year over time. Most of Norway’s key trading partners have also set their inflation targets at 2 percent.