Question

Why is a stable currency essential to trade?

Answer 1

A stable currency is a currency which is succesful in performing the three major roles which a currency is expected to perform namely store of value, unit of account and mean of exchange.

The most prudent and the most common measure of weighing a currency's stability is Consumer price index, that is weighing the price a basket of goods considered essential for an average household.

Adverse movements in either direction of the price of the basket is detrimental to the health of the nation as a whole for the following reasons

• Rise in the price of goods reduces the purchasing power of the people who in return higher wages and salaries to maintain the current standard of living.
• The real value of the savings and investments are reduced as one may not be able to purchase the same level of goods, hampering the balance maintaned.
• People who have borrowed at a fixed level of interest rates gain as with the increase in inflation, the income also increases which leads to a reduction in the burden of the loan repayment in respect to their earnings.
• It destabilizes the borrowing lending balance as the lenders demand an increased risk premium to compensate for the prospects of future inflation which makes the borrowing costlier and disrupts the situation.
• businesses are left confused in forecasting the future trends of the cost of raw materials and other costs, making it difficult to make right decisions.
• Encouraging Foreign Direct Investments into the cuountry presupposes and prenecessitates existance of a stable currency.

Hence the importance of a stable currency cannot be neglected and is seen as a major factor in the development and growth of a nation.