Question

Price stability is the sole goal of any government’s monetary policy.” Please evaluate this statement and explain why price stability can influence so many other economic factors.

Answer 1

Price stability is one of the goals of the monetary policy, rather saying that is it is the only goal of monetary policy. Other than price stability, there should be economic growth and lower unemployment level as other goals of the monetary policy. But, there is a trade off between price stability and unemployment. When there is an excessive focus upon the price stability goal, then the unemployment rate increases in the short run. It means that making price stability as the sole goal, can create higher unemployment and slowing economy. It happens, because monetary policy becomes contractionary in nature and it reduces the AD. When AD decreases, then SRAS also decreases and firms lay off workers. It leads to the increase in unemployment rate. So, it is necessary to make a balance between price stability and unemployment rate. It is the reason that a decent inflation rate (for example 2% in the USA) is considered good for the economic growth.

Further, focus upon price stability,  leads to decrease in aggregate demand and unemployment rate increases. It also slows down the industrial production as demand decreases. It causes decrease in GDP and or GDP growth rate.  Hence, there are many other indicators that get affected from the price stability as the only goal.