To control inflation, central banks have various tools at their disposal, the most common being the determination of short-term interest rates. The set of actions that they undertake is called monetary policy.
However, central banks have also set a “stable inflation” target for themselves, rather than a “zero inflation” one. The US Federal Reserve has a (dual) mandate to promote maximum employment and price stability. Now, how do you define “price stability”? Well, as the famous Cantinflas would say: there is the detail.
According to the Federal Reserve, an average growth of 2% per year over time is most consistent with its mandate. Something similar happens in our country. Article 2 of the Bank of Mexico Law states that it will have “as a priority objective to procure the stability of the purchasing power of said currency”, referring to the national currency. Likewise, the central bank adopted, 20 years ago, an annual inflation target of 3%, with a variation interval of plus/minus 1%.
Promoting economic growth is -perhaps- the most common argument to justify why central banks aim at a constant growth in inflation. It is stated that, when there is “controlled” inflation, companies would expand their production and the hiring of workers, seeking to obtain more benefits thanks to the rise in prices. At the same time, households, having more income -as a result of the higher level of employment- and expecting an increase in prices, will increase their spending and give greater priority to current consumption (it is not worth saving so much).
On the other hand, it is argued that when companies anticipate lower profits due to a drop in prices, they tend to decrease their production and demand for workers. If people lose their source of income – work – and wait for prices to fall, they will cut back on their consumption, especially at present.