Today we're going to talk about price stability. Price stability, as defined by the governing council of the European Central Bank, is the year-on-year increase in the harmonized index of consumer prices for the euro area of below 2%. Excuse me, can you explain that in simpler terms please?
Well, Imagine a shopping basket filled with a broad range of products such as bread, tomatoes, milk or things like shoes or computers. The price of this basket of goods is checked regularly and the annual price increase, and in some rare cases a decrease, is calculated. Broadly speaking, if the increase is lower than 2%, then we have price stability. Is that clearer? Okay, let's start at the beginning.
Why do we have money at all? Well, if we didn't, we'd all have to exchange things. How would a baker pay for a haircut?
By offering the hairdresser some bread. But what if the hairdresser didn't want any? How would he get paid?
It all gets very complicated. And that's how money came to be invented. It makes trade easier. But remember, it hasn't always kept its value. There were times when prices shot up.
Whoa! What's happened? Where are we?
I don't know, but I'm hungry. Look at those! Now then, what can we get for four coins?
What would you like? Two, please. That's not enough.
You've increased the price. Why's that? Because people have more to spend than there are goods to buy, the demand for my cakes has risen. and the price of flour has gone up, I have to pay the miller.
And the price of wood for my oven has gone up too. It's more expensive for me to bake now. Next.
Don't worry. You just need more money. Cool.
Thanks a lot. I don't believe it. He keeps on putting his prices up. We'll never be able to buy anything here.
Well then, you'd better have more money. Wait a second. I know you.
Your inflation. Well done. Because you're so clever, I'm going to give everyone here a cash prize.
No, don't. Wow, this is great. No, it's not. Is this too much money around? for the same number of products, it pushes up prices and money loses its value.
Look what he's asking for that. It's more expensive than it was last month. I used to be able to afford it, but now I can't. Prices are going up all the time, but my pension isn't. And my savings are losing value every day.
It's always the less well-off who suffer in times like these. So that's what inflation's all about. And once it's started, it seems difficult to stop. Here it comes again.
Let's get out of here. Glad we escaped from that. I wonder who keeps an eye on inflation nowadays?
Didn't the teacher say something about the European Central Bank and price stability? Yes. Let's try to find out some more.
Look where we are. Excuse me, is it true that your job is to keep prices stable? How do you do that? Maybe I can be of service.
Right. How can I help you? Well, we've just seen the inflation monster and the damage it causes.
Are you the ones taking care of that? Inflation monster? Yeah, he was just...
Oh, you must mean this. That's the inflation monster? But that's tiny.
It sure is. And that's because our job is to keep prices stable. We aim to keep inflation below but close to 2% over the medium term.
But how do you do that? that we figure out if there are risks to price stability we carry out two kinds of analysis first we monitor a number of factors such as economic growth and oil prices factors that could push our up prices in the short run. And second, we keep an eye on how much money is circulating in the economy, because that could push up prices in the medium to long run. But why? We know that all high inflation in the past was accompanied by too much money being in circulation.
If too much money If we're chasing too few goods, then we would risk having more inflation. Like, if everybody wants to buy the same cakes in the marketplace. Yes, but inflation only occurs if there's a general increase in prices. Not only for cakes, but for all goods and services.
But what can you do about this? For example, can you prevent the baker from raising his prices? No, we can't.
But we decide what the interest rate should be. Let me explain it to you. If you take out a credit to buy a car or a new fridge, for instance, you will pay interest calculated on the basis of an interest rate.
In other words, the interest rate is the price of money. The higher the price of money, or the interest rate, the lower the demand for money will be. People are less likely to borrow money when it's too expensive.
Exactly. That's why our job is to... to set the level of interest rates.
Making sure that prices remain stable over time. That's right. And having stable prices creates confidence. It makes it easier to save and invest. If you go shopping in a few months'time, things will cost roughly the same as they do now.
Also, companies invest more, helping the economy to grow and creating jobs. And that must make a country more prosperous. You see, an increase in this little fellow can be a problem for the economy.
He can even make people lose trust in their money, which is why we at the European Central Bank and the Eurosystem take our mission so seriously. Eurosystem? That's the European Central Bank and the National Central Bank of the countries in the Euro area.
But you know, That's not all we keep an eye on. Really? Yes.
You see, this is deflation. What's that, then? Deflation is a general decrease in prices. Sounds great. No, it's not.
You see, just like inflation, it can also damage the economy. For example, if all prices are steadily declining, you'll delay buying something, expecting it to cost less a week later and even less a month later. For the same reason, same reason a company might decide to postpone its investments and the economy would suffer. These little guys are destructive! And what is the primary objective of the European Central Bank and the euro system?
Well? To maintain price stability. Good. And to combat the inflation monster. Hmm well I suppose you could call it that.
Yeah!