CFA Level I · CFA Level I Exam · Monetary Policy
A central bank pursues price stability as its main objective. It most likely regards a low and stable positive inflation rate as preferable to zero inflation because zero inflation:
A low positive inflation target is preferred because zero inflation raises the risk of falling into deflation and leaves the central bank little room to cut nominal interest rates when the economy weakens. Zero inflation does not guarantee faster growth or remove the need to anchor expectations.
- Araises the risk of deflation and limits room to cut ratesCorrect
- Bguarantees faster long-term growth in potential output
- Celiminates the need for any inflation expectations to be anchored
Explanation
With zero inflation, a negative shock can push the economy into deflation, and nominal policy rates may hit the lower bound, limiting the central bank's ability to stimulate. The other options are incorrect claims.
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