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INFLATION

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by

Gabriella Turner

on 22 July 2013

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Transcript of INFLATION

EXCHANGE RATE
EFFECTS OF THESE CHANGES ON INDIVIDUALS AND BUSINESSES
ACTIONS OF GOVERNMENT AND REGULATORY BODIES
hi
WAGES
INTERNATIONAL COMPETITIVENESS
Lower inflation =
Aus exports cheaper, relative to imported goods =
Increased international competitiveness

--> positive effect for individuals and businesses
MONETARY POLICY
MEASURING INFLATION
Low inflation will result in low interest rates as the RBA loosens monetary policy in an attempt to increase economic growth.
High inflation = less equitable income distribution

Consumers holding monetary assets (savings) or receiving fixed wages will be unfavourably affected

Consumers and businesses with non-monetary assets (machinery, land, shares/stocks) will benefit

Fundamentally, low inflation will have positive effects on income distribution within Australia

INCOME DISTRIBUTION
CHANGES IN INFLATION
1993 'inflation targeting'

desired targeted inflation band of 2-3%

Ensures that the economy does not experience deflation which occurs when the inflation rate falls below 0% and can result in an increase in the real value of debt.

Provides regulation for decision in regards to monetary policy whilst managing inflationary expectations within the private-sector.

Extremely effective management strategy as there has been little volatility and a difference of only 2.7% inflation between the highest and lowest annual rate over the last 10 years
'Inflation Targeting'
CURRENT TRENDS IN AUSTRALIA
ECONOMIC GROWTH AND UNCERTAINTY
Resources
INFLATION
ANALYSING
CHANGES IN
INFLATION

INTEREST RATES
FISCAL POLICY
MICROECONOMIC REFORM
Inflation = A sustained increase in the general level of prices over a period of time (usually 1 year).
CAUSES OF INFLATION
COST-PUSH
DEMAND-PULL
IMPORTED INFLATION
INFLATIONARY EXPECTATIONS
Assists in promoting low inflation within an economy.

Lowering protection levels = higher competition for domestic producers = increasing difficulty for firms to raise prices

Labour market policies can be used to alleviate non-cyclical unemployment and increase productivity of businesses in the long-term

For example, the government’s goal of a budget surplus in 2012-13 reflected a strategy of reducing inflationary pressures caused by the mining boom, thus taking pressures off rising interest rates.

Increased taxation + decreased expenditure = reduction in demand pull pressures = reduction in demand-pull inflation


As a generalisation, high inflation = RBA tightening monetary policy = reduction in both demand-pull and cost-push pressures within the economy



The higher the CPI the higher the inflation

Underlying rate

= a measure of inflation that removes outliers and one-off
_________________
movements in prices
-
Trimmed mean

= Median figure after removing outliers
-
Weighted mean

= Mean score where some figures have been given
___________________
greater or less significance

- Underlying rate is useful because it removes volatility and provides a
__
‘true’/ more accurate reading


Headline rate

= a measurement of inflation that does not remove outliers
______________
or one-off movements in prices.

- This can give an inaccurate and distorted measurement of inflation yet can be useful in viewing the effects of particular events on economic growth and prices. E.g. abnormally high banana prices after cyclone Yasi in 2011

Currently Australia is in a stage of 'recovery' following the GFC, experiencing periods of sustained low inflation (approximately 2.5% as of March 2013) due to low economic growth, a lack on consumer confidence, struggling non-resource sectors and a slow down in the commodities boom.
Australia's currently low inflation trends will have positive impacts on businesses and individuals as it reduces uncertainty. Consequently, businesses will be more willing to invest and consumers more willing to spend, hence resulting in sustainable economic growth and higher standards of living.
It is important to note that nominal wages adjust slower than inflation!

Essentially, nominal wages refer to the dollar value that employees receive for their contribution to a business. Nominal wages are a set value and are not adjusted to inflation

In times of low inflation, consumers retain their purchasing power meaning that there will not be an increase in nominal wage demands.
--> positive for individuals

This will result in positive outcomes for employers as there will not be an increase in labour costs or, by extension, the business’ expenses in regards to the factors of production.
--> positive for businesses

Low inflation will also make it possible to avoid the wage-price inflationary spiral
UNEMPLOYMENT


For Example: During the GFC the Australian economy experienced low economic growth, low inflation in 2009 (1.7%) and simultaneously high unemployment rates (5.6%).




Yet the Phillips Curve is limited in the long-term as periods of sustained low inflation will result in a loosening of monetary policy and an in economic growth, consequently decreasing unemployment benefiting both firms and individuals.


low inflation = high international competitiveness = increasing demand for Australian goods and services = increasing demand for Australian currency =
an appreciation of the AUD

Vice versa for higher inflation equating to a depreciating AUD

2000-2001
:
Strong inflationary pressures with annual rates reaching 4.5% in 2000.
Cause: Introduction of GST

2005-2008:
Strong inflationary pressures and higher inflation. Annual rates reaching 3.5% in 2006 due to high levels of economic growth.
Cause: Commodities Boom

2008-2010:
High levels of inflation peaking at 4.4% in 2008. Sudden decline in inflationary pressures to 1.7% in 2009 and 2.9% in 2010.
Cause: GFC

2010-2013:
Low inflation rates of 1.7% in 2012.
Cause: low economic growth, lack of consumer confidence and struggling non-resources sectors following the GFC.
Consumer Price Index (CPI) = an index of the prices of a basket of key goods and services weighted according to their significance in the average Australian household. Things in the basket would include; water, food, electricity, healthcare, housing etc.
INFLATION RATE (%) =
Where

Where
= the value of CPI in the current year
= the value of CPI in the previous year
For example: The link between inflation and economic growth can be seen in the commodities boom from 2005-08 with high inflation resulting from high economic growth as the economy reached ‘full capacity’. Yet this growth was unsustainable!
- Rising import prices means that domestically produced goods can also raise their prices without losing international competitiveness. This increase in the cost of goods and services will result in inflation

- The same goes for a depreciation of the AUD which will result in imports being relatively more expensive causing consumers to buy more domestic goods and consequently causing demand pull inflation

If consumers expect prices to increase in the future they will bring forward their purchases resulting in demand-pull inflation.

Essentially a self-fulfilling prophecy
For Example: Conversely, in Australia's current economic environment the RBA has loosened monetary policy with interest rates being set at 2.75% in April 2013 in attempts to stimulate economic growth
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