The central bank can introduce measures to correct a change in the aggregate price level towards deflation or inflation.
The aggregate price level refers to the general or aggregate price of collective goods and services produced in an economy over a period of time. The calculation of this price is determined by several economic factors, including aspects such as the effects of excess demand and the effects of excess supply. Economists rely on this number as a means of making decisions about the macroeconomic condition of a nation’s economy.
When the price level of aggregate demand is relatively stable over a period of time, this indicates to interested observers that demand and supply are at a relatively desirable level in the economy. Indicators of changes at this level include factors such as deflation and inflation, with their respective effects on the economy. A notable change in either direction can lead to the introduction of mitigating macroeconomic factors intended to correct the imbalance, such as monetary policies that can be introduced by the central bank of an economy and fiscal policies that can be introduced by the government.
A fall in the level of aggregate prices, also known as deflation, is usually the result of very low demand for finished goods by consumers in an economy. When consumers don’t buy as much product as they used to, the aggregate price of products will fall in response to slow markets. In such a situation, a central bank might try to artificially stimulate the market by manipulating interest rates. A lower interest rate may encourage consumers to get more money from banks and spend more. The consequence of the increase in the demand for products and in consumer spending will be an increase in prices.
An increase in the price level, or inflation, is usually due to excessive demand for goods and services that may be greater than the economy can sustain. When this type of activity begins to overheat the market, this is reflected in rising prices. The central bank may raise interest rate levels as one of the possible measures to stop or minimize spending and demand that are raising the general price of goods and services.