Inflation
Inflation has a direct impact on a country’s economy. Inflation is defined as a continuous and considerable rise in prices. Inflation redistributes income and wealth from lenders to borrowers. This is why inflation is a very important issue with banks. Because of the great influence inflation has, countries have implemented policies to have target inflation rates. The European Central Bank (ECB) and the central banks of Canada, New Zealand, Sweden and the United Kingdom have all implemented this idea of a target inflation rate. However many central banks have not formally adopted this title of inflation targeting but clearly has followed the approach. An example of this is our Federal Reserve, who has for the last twenty years maintained a low and stable inflation rate.
Inflation targeting has been practiced by many countries for the past 40 years. These countries choose a target that is low but not too low. Their actual target is important for many reasons. These countries understand the nature and influence inflation rates have on the economy and use this to base and set target rates.
Banks who target inflation rates try to keep it low. The target inflation rate is 1-3% for Canada and New Zealand and 1.5-2.5% in Sweden. These countries attempt to keep it low for numerous reasons. High inflation can becomes a waste of resources. Therefore, low inflation minimizes waste. There are also other problems associated with inflation such as menu cost, shoe leather costs and uncertainty. Menu costs arise because high inflation induces firms to change their posted price more often. The higher rate of inflation, the more often restaurants have to print menus. Shoe leather costs are the cost accrued by more frequent trips to the bank to withdraw money because of rising inflation. There is uncertainty because these higher inflations rates cause the greater variability in relative prices. This leads to microeconomic inefficiencies in the...
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