Why is it important to keep Inflation low and stable?


A low and stable inflation improves the well-being of the population. This takes place in several ways: 

 

  • Low inflation promotes the efficient use of productive resources. On the contrary, when inflation is high, a portion of an individual’s time and part of the resources of the economy are invested in searching for mechanisms to defend themselves against inflation. For example, when inflation is high, companies must allocate more resources to manage their portfolio in order to prevent financial losses. These are unproductive uses that do not generate wealth to society.

  • Low inflation reduces uncertainty. It has been observed that economies with high inflation indicators also suffer from a more variable inflation. Uncertainty can negatively affect the expected profitability of investment and therefore long-term growth. Greater uncertainty also implies that relative prices lose their informational content about the relative scarcity or abundance of goods and factors in the economy. This prevents an efficient allocation of resources, consequently decreasing economic growth.

  • Low inflation encourages investment. The most important economic decisions made by individuals and companies are usually long-term decisions: starting a factory, forming a company, investing in education, or buying a house. These decisions critically depend on the degree of uncertainty of the future. A low and stable inflation is an indicator of macroeconomic stability that helps people and companies to make investment decisions with confidence.

  • Low inflation avoids arbitrary redistributions of income and wealth, especially against the poorest population. Workers and retirees have fewer mechanisms to protect themselves against the inflationary erosion of their income. There are no indexation clauses for income, or they are not frequent. In Colombia, for example, salaries and pensions of retirees are readjusted once a year. Besides, the lower the income of the people, the more likely they are to have fewer defense mechanisms against inflation, such as savings or property. For this reason, increasing inflation entails redistribution of income against the poorest population.

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This content has been translated into English for informational purposes. Upon any query regarding its interpretation or enforceability, the Spanish version shall be deemed official, and will prevail over the English version. The authors of specific texts such as working papers or articles select the language of publication; therefore, there might be cases in which the content may only be available in English. 

 

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