First, a direct efficiency-enhancing effect of price stability is the reduction of risk premia in interest rates as a result of diminished uncertainty about future inflation and future policy rates. Second, by improving the transparency of price movements in financial markets and anchoring inflation expectations, price stability reduces the likelihood of misperceptions about possible future asset returns.
4 In turn, this lowers the risk of misalignments between asset prices and economic fundamentals, which fosters both the stability and efficiency of financial markets. Third, by maintaining price stability, monetary policy also allows banks and borrowers to avoid potential balance sheet problems related to unexpected but persisting deflation.