Why is price stability (or controlling inflation) the ‘holy grail’?
Entrepreneurs require stable economic environments within the countries that they operate. One of the prerequisites of such an environment is price stability. The current Conservative Government in line with their previous administrations are ‘fixed in their approach’ of controlling inflation. Gordon Brown gave the control of interest rates to the Bank of England as he became Chancellor in 1997, urging them to use their power to assist and guide inflation always to be under 2%. Price stability and the control of inflation is always the top of any Western economy’s agenda. But why?
The answer to this question lies in the economic environment that exists in any country where inflation roars and prices become unstable. Then there is economic misery and not only uncertainty, but also bankruptcy and exchange rates which become extremely volatile. The economy becomes uncontrollable.
This occurs with two economic scenarios..
The first would be when economies are borrowing more than they can afford or in other words, the country in question is bust. Imagine when economic events contrive such that the country cannot export goods for sale, nor produce enough for the population to live. Examples in history include: post First World War Germany and the current situation in Zimbabwe. Effectively no other country trading with the country has any belief that it will be run properly and return to normality, so much that the currency becomes worthless and the central bank then prints money to provide the nation with enough money to buy goods. It is an ever decreasing circle until something catastrophic occurs to create the stability. Generally a change in the administration!
The second scenario and more common perhaps is when wage demands outweigh the affordability of the government (if they are public service) or private companies. Over a period of time such wage inflation creates a rise in prices, and companies need more income to pay the wages. That inflation is caused internally but when countries are reliant on minerals or raw goods any fluctuation in their price can de-stabilise economies, as we have experienced with oil in the latter half of the 20th century and since. This is less noticeable than the first scenario and could be labelled ‘inflation creep’. This is why every government is concerned that inflation is firstly ‘knocked out’ of the economy and then controlled.
Various mechanisms are available to government’s to control inflation such as interest rates, fixed exchange rates, taxation and public sector expenditure. All of which have their own political agenda and are not for this blog..
Next week I shall be discussing: The Benefits of Having a Non-executive director. In the meantime, please do share your opinion on this post below.