Consumer prices are a key indicator of how an economy is evolving, and they are continuously monitored by households, companies and economic policymakers (central banks, governments and international institutions).

On the one hand, movements in consumer prices influence households’ and companies’ decisions on consumption and investment.

On the other hand, economic policy decisions (especially monetary policy) take into account the recent dynamics and outlook for consumer prices.

A range of factors affect consumer price developments, including: conditions in the real economy (for example, how the pace of growth compares with the rate at which production factors are being used at capacity); weather patterns, which affect agricultural supply and, in turn, food prices (these account for over 30% of the consumption basket in Romania); fluctuations in international quotations for crude oil and other commodities; developments in the foreign exchange market, which influence the prices of imported goods and services; economic agents’ expectations regarding consumer prices; economic policy decisions; and the incidence of endogenous shocks (crises within the economic system) or exogenous shocks (such as the coronavirus pandemic).

When we talk about inflation, we mean a rise in consumer prices. In periods of high inflation (as Romania experienced in the last decade of the 20th century during the transition from a state-controlled to a market economy), households’ welfare deteriorates and firms allocate resources inefficiently.

An acceleration in consumer price growth erodes households’ real disposable income (purchasing power declines), which will dampen future demand for goods and services.

At the same time, when consumer prices rise rapidly, corporate investment decisions become distorted. Businesses may struggle to tell whether the price increases for their goods and services reflect a temporary pick-up in demand for them, or a broad-based rise in prices across the economy.

By contrast, deflation describes a decline in consumer prices. The most well-known period of deflation was the Great Depression (the global economic crisis of the 1930s).

During deflation (falling consumer prices), households and companies postpone consumption and investment decisions, given the prospect of even lower prices ahead. This can set off a deflationary spiral, which is detrimental to the economy (demand for goods and services weakens, companies lay off workers and households’ welfare is severely affected).

In this context, consumer price stability (avoiding both high inflation and deflation) plays a fundamental role in the efficient allocation of resources, which is essential for sustainable economic development.

Indeed, in most countries central banks have maintained price stability as the primary objective of monetary policy.

By price stability we typically mean average annual inflation of around 2% in advanced economies. In Romania, the National Bank targets annual consumer price inflation within a 1.5%–3.5% range, centered at 2.5%.

In Romania, after a period of hyperinflation at the start of the transition from a state-controlled to a market economy (annual consumer price increases of over 100% in 1990, 1991, 1992, 1993, 1994 and 1997), a disinflationary trend took hold from 2000 onwards.

This disinflation process over recent decades was supported by globalisation and liberalisation (including in the context of accession to the European Union) and by the National Bank of Romania’s adoption of an inflation-targeting framework in 2005.

In 2020, consumer prices in Romania rose at an average annual rate of 2.6%, down from 3.8% in 2019, as shown in the chart below. Notably, last year inflation in Romania was within the central bank’s target band.

 Consumer price developments in Romania (%, y/y)

Editor: Andrei Radulescu, Director, Macroeconomic Analysis, Banca Transilvania