A short essay on higher long-term economic growth through price stability for the course Trade & Money at the Amsterdam School of International Business. The piece was graded with an 8.6.
Higher Long-Term Economic Growth Due To Price Stability
Rutger Reijnoudt Brouwer, 2IBS1
500732947
Price stability leads to the prospect to forecast. Consumers can be sure that it does not matter
whether they purchase a pair of shoes either today or tomorrow, their money shall not be worth
significantly less than the day before thanks to the price stability. Due to the fact that people know
their money will be worth the same value in the future, people dare to invest and save more.
When the inflation risk is low and reasonably stable, people do not waste resources attempting to
protect themselves from inflation. These savings and investments shall increase the potential GDP
for the fact that for instance an investment in human capital such as education is likely to occur.
Consumers and firms shall save and invest with confidence that the value of money will be stable
over time, this because, as just explained, the currency can be used as store value. A monetary
unit that serves poorly as a store of value compromises an economy's savings and reduces its
willingness to trade.
Thus, a credible currency must be established for people to engage in labor and trade. Even more
so, one of the primary functions of money is to measure the worth of goods, if the price would not
be stable and would fluctuate, the currency is not useful as an unit of account.
Another way in which an economy can benefit from price stability is that more people are willing to
work and therefore the Labour Force increases. Employees are bound to obey labour contracts, if
these contracts can not ensure the employees will match the inflation it shall directly discourage
the workforce to sign a long-term employment contract; therefore, potential GDP growth shall occur
when there is a price stable economy. A low risk of inflation can ensure their buying power shall not
be influenced over time by an increase in prices, which means more consumption, investing and
saving; hence, long-term economic growth shall arise.
The third link has to do with costs of borrowing. Price stability makes sure that there does not have
to be an inflation risk fee included in the loans, because people do not have to protect themselves
from possible fluctuations in the worthiness of their loans. Even more so, entrepreneurs could start
up their companies way easier if the costs of borrowing are less, which increases the
competitiveness of the market. Competitiveness generates higher performance and better
allocation of resources. When people are able borrow more, large investments are more likely to
occur; hence, potential GDP growth is likely to occur since these large investments could be in
technological advancements.
(451 words)
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