Inflation.

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Presentation transcript:

Inflation

What is inflation? A sustained increase in the general level of prices in an economy. Maintaining low inflation is a major objective of economic policy because of the benefits that lower inflation provides to the economy in the long run.

How is it measured? Inflation rate (%) = CPIcy - CPIpy x 100 Where CPI = Consumer Price Index cy = current year py = previous year

How is CPI measured? The Consumer Price Index is calculated by summarising the movement in the prices of selected goods and services, weighted according to their significance for the average Australian household. These include: Food Housing Transport Alcohol and tobacco Clothing and footwear Communication Recreation Furnishing, supplies, services Health

Main causes of inflation Demand-pull inflation (AD > Y) Cost-push inflation (costs of production increase) Inflationary expectations Imported inflation (increase in cost of imported goods or depreciation of $Aus) Government policies (e.g. GST) Excessive increases in the money supply (where increase in money supply > growth rate of the economy)

Effects of inflation Economic growth and uncertainty – savings and investment may suffer Wages – wage-price inflationary spiral Income distribution – impact of inflation on fixed incomes and savings Unemployment International competitiveness – international investors are reluctant to invest $ in a high inflation economy Exchange rate impacts Interest rates

Sustaining low inflation Monetary policy is the major tool used to reduce inflation. If inflation starts rising, the Reserve Bank is able to increase interest rates throughout the economy by tightening monetary policy. Pre-emptive monetary policy by the RBA in recent years has had the effect of lowering inflationary expectations.

Microeconomic reform policies Microeconomic policies are aimed at certain sectors of industry. Reduced protection has lowered the price of imports. This makes it more difficult for domestic producers to raise their prices. Deregulation of the labour market has reduced the problem of cost-push inflation. Wages increases are linked to productivity improvements – the economy will be able to afford real wage increases without inflationary pressures.