Of course, some degree of price changes are an important feature of any economy. These changes entice resource owners to seek out the most efficient production. Market shortages cause prices to rise and market surpluses cause prices to fall. These price changes signal the reallocation of resources toward the production of goods with shortages and away from goods with surpluses.

Problems, however, result when prices fluctuate significantly--rising, then falling, then falling more, then rising back again, then rising even higher before falling. Unstable prices create uncertainty throughout the economy and can cause a haphazard, and usually undesirable, redistribution of income and wealth.

Uncertainty

For example, suppose that wages, the price of labor, fluctuate widely from month to month, rising one month, then falling the next. With such a variation in income, workers find it difficult to commit to any long-term expenditures (such as borrowing funds to buy a house or car). Of course, workers could "save" income during high wage months to compensate for low wage months, but the steady income stream that comes with stable prices makes life much easier to manage.

Likewise, if consumer prices also fluctuate widely from day to day or week to week, each trip to the market is an exciting adventure. Are prices 50 percent higher or 75 percent lower today than last week? How much money does a consumer need to buy groceries THIS WEEK?

Price stability is probably even more valued by businesses and governments. A significant amount of business and government activity involves long-term commitments--such as investing in multi-year capital construction projects, anticipating tax or revenue collections, and planning expenditure budgets. Widely fluctuating prices can make long-term planning virtually impossible and play havoc with operating a business or with running a government.

Haphazard Redistribution