Understanding Monetary Policy
Inflation and deflation are two concepts that play a critical role in monetary policy. Inflation refers to an increase in the general price level of goods and services over a period of time. Deflation, on the other hand, refers to a decrease in the general price level of goods and services over a period of time.
Inflation can be caused by a variety of factors such as an increase in demand, a decrease in supply, an increase in production costs or a decrease in the value of money. Inflation can have negative effects on the economy, such as a decrease in purchasing power or a decrease in the value of savings. This is why central banks aim to keep inflation at a stable and low level, usually around 2%.
Deflation can also have negative effects on the economy, such as a decrease in demand and an increase in unemployment. Therefore, central banks aim to avoid deflation and to keep prices stable.
One common measure used to track inflation is the Consumer Price Index (CPI), which measures the change in the price of a basket of goods and services consumed by households. The CPI is used by central banks to set interest rates, which can affect inflation. If inflation is too high, central banks may increase interest rates to slow down consumer spending and reduce demand for goods and services. If inflation is too low, central banks may decrease interest rates to stimulate the economy and increase demand for goods and services.
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