Price Level Targeting
Categories: Econ
Ready...aim...fire! Ah, a near miss on that price level target. Try again, Fed.
Central banks, such as the Federal Reserve in the U.S., oftentimes try to hit a certain price level via price level targeting. These banks tinker with monetary policy, doing things like raising or lowering interest rates as if they're economic demigods to keep inflation at an ideal rate. Of course, ideal inflation rates are subjective, but in general: hyperinflation is bad, and low, stable inflation is considered good.
When there’s a lot of inflation, it means prices are going up, up, up. If they keep going up, people will eventually stop taking this whole “money” thing seriously. "Bread cost me $3 last week, and now it costs $500? Psshh, I might as well use my $3 for toilet paper."
A little inflation is all right, since that’s just the economy growing. Growth means more money in the system, which means more demand for things, which raises prices.
Central banks use price level targeting as a way to keep the economy growing, but at a stable pace; nobody wants hyperinflation. A nice inflation number? Around 2% per year. If inflation falls below that, the Fed might lower interest rates, encouraging borrowing and spending. If inflation is above 2%, the Fed might raise interest rates, making stuff more expensive so that the price level stops rising so much.
Targeting prices to affect inflation (rather than targeting inflation directly) is easier for central banks, because they can see various baskets of goods changing prices. But that also makes it riskier, since if they’re focusing on one basket of goods and not others, they could end up amplifying the business cycle rather than tempering it. It can get politically messy too, depending on which basket of goods you decide to use for price level targeting. For these reasons, price level targeting is kind of...out of vogue.
See: Price Level.
Related or Semi-related Video
Econ: What is General Price Level?4 Views
And finance Allah shmoop What is general price level You
go to the sort of by your usual weekly staples
canned chili caramel dip frozen bananas pickled kiwi Ryan's and
replacement anima tubes Every week you buy the same things
weekend week out Your grocery cart has the same four
items It's been like this for years Same stuff every
week You're a creature of habit And yes you have
those digestive problems that you might want to check out
But that's for another video OK overtime prices for the
individual items move in all different directions Prices for some
of the items might go up while prices for others
might go down even when everything moves in the same
direction While the prices don't change at the same rate
some see big jumps in price Some barely see moves
at all For instance in the past year the price
of a can of chili rose from a buck forty
six to a buck forty nine an increase of about
two percent No big deal however Pickled kiwi rinds have
jumped to seven dollars Sixty nine cents from seven dollars
nine cents an increase of nearly eight and a half
percent Yeah much bigger deal Meanwhile the price of anima
tube's actually fell during the year leaking or dipping to
six dollars forty nine cents from six seventy four Well
those air individual price levels But what about general price
levels Will the general price level is a measure of
prices across an entire system not just the direction of
a price the direction of all prices You know general
prices Right So this week all the items in your
grocery cart cost you twenty dollars Two cents That's your
general price level If you want to make an economic
indicator out of it well call it your personal general
price indicator or PGP I once you know the general
price level while you contract overall price changes over time
So a year ago the four items that you buy
every week totaled nineteen dollars Forty two cents This year
Twenty dollars two cents Your PGP I rose three point
one percent from last year And there's a map new
minus old overalls that you get that percent growth formula
thinking well In real life he's general price levels are
used to track inflation or deflation though well it doesn't
happen all that often deflating things People like to rattle
off inflation stats but it's actually a tricky thing to
really track Honestly you're fairly er accurately in a complex
economy prices for various products are moving in different directions
all the time and a different rates all the time
Combining all this action into a single stat well is
extremely complicated There are a lot of competing indicators that
measure the general price levels in the overall economy The
most high profile of these is the Consumer Price index
or CP I It works like the total price is
for your weekly grocery basket except that the CP I
includes a big basket like a basket with a representative
sample off of all the stuff people by at least
all the stuff that CPS measures And it's like thousands
of things Your personal consumer price index may include just
those four items that you buy every week You know
the basket where one in four of the items are
enema tube But the C P I R consumer price
index is a lot broader thousands of items that people
die all the time or in that index So yeah
enema to prices make up well hopefully far less than 00:03:13.87 --> [endTime] twenty five percent of that index What