Discuss about the Contemporary Issues and Economic Activity.
This essay focuses on inflation in Australia and various government measures by the government of Australia. Inflation in a country plays crucial role in determining the aggregate level of demand for goods and services by changing price level of goods and services over a period of time. Maintaining an adequate inflation rate is necessary from the perspective of economic growth of the country in the long run. Inflation can be measured by the consumer price index and the whole sale price index (Australian Bureau of Statistics, 2016). Many economic, non-economic and international factors affect the rate of inflation. Controlling the inflation level in an economy requires time and combined efforts of the concerned authorities. Generally, the monetary measures are implemented by the central bank of the country while the government is responsible for implementing the fiscal policy measures. However, for effective results in controlling inflation in the country, it is necessary that both government and the central bank of the country work in harmony to achieve their common goals.
The following essay discusses the scenario of inflation in Australia for the last five years from 2011 to 2015. It seeks to outline the country specific factors that led to fluctuations in the inflation rate of the country. Furthermore this essay also focuses on how the inflation impact on the Australia’s growth and the living standard of households. Further, the essay discusses different policy measures adopted by the Federal Government of Australia and the Reserve Bank of Australia in addressing this economic phenomenon. The essay also talks about these policy measures by categorizing then into two broad categories of demand side policy and supply side policy. Finally, this discussion tells about the inflation and better government policy that helps the economy to boost the efficiency of business operation and control the inflation.
Inflation is a common economic phenomenon experienced by all the economies of the world. It refers to rise in price of goods and services in a particular period of time and is calculated on the basis of consumer price index and whole sale price index (Hubbard, et al., 2014). Consumer price index measures the changes in price of goods and services that present proportion of spending by households (Australian Bureau of Statistics, 2016). A rise in inflation results into decrease in purchasing power of the consumers. This is because a rise in inflation leads to increase in general price level of goods and services in the economy and decrease in value of money. Hence, consumers are able to purchase less for every dollar they spend.
Australian economy is the mixed market economy and fifth largest economy in the in the world, according to the World Bank survey. Currently, the RBA targets the inflation rate in the range of 2 to 3% in order to maintain an adequate aggregate demand in the economy. Inflation increased due to many reasons such as supply of money, national debt, demand pull effect and exchange rate of currency. Inflation between 2% to 3% is a positive aspect which persuade consumer to spent more money for goods and borrow money. Furthermore, Inflation is an economic statistics that point out the stability of the country’s economic position. It is measured as the changes in consumer price index over a period of time.
Australia’s inflation rate is 1% in 2016, which is a sign of healthy economic condition. Inflation is calculated using the consumer price index, which shows the changes in the consumer goods and other items. Australian Bureau of Statistics reported that the Australian core inflation rate increased in March 2016 as 1.67%. On the other hand, many factors affect the Australian inflation rate such as cost inflation, aggregate demand, higher interest rate, and heavy government tax (Inflationdata.com, 2016).
Inflation has major impact on the country’s economy, the impact of inflation includes Economic growth and uncertainty, Wages rate, Income distribution, Unemployment, interest rate and international competitiveness for a country. The inflation rate witnessed by the Australian economy in the last five years is as follows:
Fig. 1 Inflation over five years in Australia
As shown in above chart, the inflation rate in 2011 was highest as compare to other years. Current base year for Australia is taken as 2011-2012 (Index points= 100). In contrast to this, higher rate of inflation increases the cost of goods and also affect the competitive edge in global market (Statista, 2016). Higher fluctuations in currency of country can impact the economic growth. As compared to other years, inflation rate in the year 2015 was the lowest. Australia’s consumer price index rose to 1.7% in last quarter of 2015. In this time the price of goods increased faster but the cost of transport decreases it slowdown the cost of housing. In starting of year 2014 that inflation rate was high furthermore it decreases over the year ending. Australia’s economy is mainly based on the mining and service sector (Finch, 2012). Wages is one of the important factors that affect the price of goods and services. In 2013 and 2014 higher wages paid to the workers it accelerates the inflation by more purchasing power of consumers (Inflationdata.com, 2016). The oil price and energy prices was very high during the year 2012 and 2013 because of the international conflicts it directly affect the pressure on cost it leads to the inflation. In 2013 when the mining industry of Australia was on the boom then it affected the Australian economy as to appreciation in Australian dollar, industries exposed to trade such as manufacturing and agriculture. At this time the unemployment rate was very low and the oil prices was high it triggered the inflation as the upward movement by 2.48%. Boom in mining industries boosted the purchasing power of households and led to increase the volume of output in Australian economy. In 2009-2011 higher interest was paid in return to the bank loan, it increased the production cost for firms. Rise in government tax also pressured the cost of inflation in Australia. Inflation rate was highest in 2011 as compare to the following years, it was 3.33% (Morris, 2014). At the same time the inflation rate arose due to the natural disaster in Australia, farms had damaged and the cost for farmers to growing also increased for the vegetables and fruits. High inflation rate affects the nation’s economic performance and decreases the living standard of people. Recently in 2016 the inflation rate is measured as 1%. Reserve bank of Australia measured the inflation rate between 2% to 3%, because it is the good position to maintain the economy and for cuts the interest rates (Reserve Bank of Australia, 2016). Consumer price index has fallen by 0.2% due to decrease in the price of petrol. The petrol price is an historic fallen in last seven years in quarter march 2016 (The Guardian, 2016). Lower inflation rate positively impact on the overall economic condition which helps in increasing the operation of business at national or international level both.
Inflation is an economic problem that leads to creation of negative impact on many economic outcomes like economic growth, global competitiveness and income inequality. In addition to this, higher the level of inflation, greater is its consequences. Therefore, the major objective of economic policy of a country is to maintain a low level of inflation that leads to creation of benefits in the long run. Government of Australia in partnership with Reserve Bank employs monetary and fiscal policy for maintaining a sustainable level of inflation (between 2 and 3%) in country. These policies can be categorized into demand-side policies and supply-side policies thereby indicating the underlying causes of inflation i.e. demand or supply.
Demand-side policies are used to control demand inflation. These policies effectively try to reduce excess aggregate demand so that there will no longer be shortage of goods and services.
The primary responsibility of formulation and implementation of monetary policy is in the hands of Reserve Bank of Australia. Monetary policy is considered as most important tool for maintaining lower level of inflation in the country. It is effectively defined as process used by monetary authority of country for controlling the money supply. In addition to this, monetary policy is effectively helpful in maintaining long-term growth in the economy (RBA, 2016). The main objectives of monetary policy of Australia include maintaining of stability of currency, full employment level and economic prosperity and welfare of the people of Australia. Moreover, prior to deregulation of monetary policy, the Reserve Bank of Australia effectively worked through direct control on financial institutions and financial market operations. It imposed control on reserve requirements, interest rate charged by banks and other balance sheet restrictions. However, as per present deregulated financial market in Australia, monetary policy effectively works through maintaining bank rate in a way to control the level of inflation in the country.
Monetary policy is effectively helpful in controlling inflation level which preserves the value of money and promotes strong and sustainable growth in Australian economy. Furthermore, monetary policy is maintained through various actions which involve increasing the interest rate and changing the amount of money that bank is required to keep in its bank reserve. Therefore, higher interest rate increases the cost of borrowing which decreases spending. This further leads to lower level of inflation in the country. Increased interest rate also makes it attractive for the people of country to save money (Hubbard, et al., 2014). Additionally, increase in interest rate affects the cash flow, supply of credit and exchange rate which in turn affects the aggregate demand in the country. Furthermore, increase in interest rate leads to different impact on both debtor and creditor households (RBA, 2016). It leads to decrease in cash flow for debtors and increase in cash flow for creditors. Debtor households are more affected by change in cash flow due to change in interest rates. This leads to reduction in their total household spending, which effectively helps to reduce the level of inflation.
Cash rate has a powerful influence on interest rate to be charged by bank. Cash rate is the Australian base rate. It is the rate charged by the central bank on providing overnight loans to commercial bank as, a large volume of withdrawals and deposits are incurred in the banks every day on a regular basis. This leads to situation of surplus or shortage of funds in the bank. Therefore, if there is shortage of fund in bank then it increases the demand of overnight funds (RBA, 2016). An increase or decrease in the cash rate leads to greater impact on interest rate to be charged by bank on mortgage, savings and loans. Therefore, official cash rate of RBA is used as benchmark by commercial banks for the interest rate that they use to charge their borrowers.
For controlling the level of inflation in country, RBA makes decision to raise the cash rate which in turn affects the interest rate to be charged by commercial bank on borrowers. This leads to decrease in demand and a reduction in level of inflation in the country. In addition to this, RBA (Reserve Bank of Australia) uses its open market operations for maintaining cash rate as per target (1.5% as per 7September, 2016) set by board for effectively controlling the supply of funds that are available to commercial banks in money market. The cash rate is determined in money market by effectively identifying the relation between supply and demand of overnight funds required by commercial banks.
Currently, the cash rate set by RBA to achieve its inflation target is 1.50% (RBA, 2016). Such low level of cash rate points towards the fact that the current monetary policy of RBA focuses on expansionary measures that lead to increase in aggregate consumer demand. This will further help the RBA to achieve its inflation target of 2-3%.
Fiscal policy can be considered as another economic tool that can be effectively used by Government of Australia for controlling the level of inflation in the country. This policy involves change in government spending and level of taxation by government. The changes in fiscal policy effectively influence the aggregate demand and level of economic activities in country (Enright and Petty, 2016). It is also helpful in stabilizing the fluctuations and maintaining effective level of growth in the economy.
Fiscal policy plays an important role in effectively controlling inflation in country. Adjustments in the expenditure and revenue level of government through its spending and taxation changes leads to budget surplus or deficit. An effective fiscal policy leads to an improvement in government budget deficit by increasing the level of taxation. Fiscal policy in Australia effectively focuses on keeping the debt low and retaining the level of flexibility, for protecting the country from negative impact of inflation (Blanchard and Sheen, 2013). For reducing aggregate demand in the country, fiscal policy involves reduction in government spending and increase in the level of taxation. Increase in direct taxation by government for controlling inflation leads to reduction in disposable income of the individuals in country (McTaggart, et al., 2012). Therefore, decrease in aggregate demand leads to decrease in level of inflation in Australian economy.
Supply side policies are government policies which help to increase the productivity and level of efficiency in the economy. These policies are helpful in controlling cost inflation that is caused by increase in production costs. Supply side policies include:
High tariff rates leads to inefficiency in business and also reduces the level of competition from imports. Therefore, by adopting the policy of free trade and reducing the general tariff rate, the government helps manufacturing firms to reduce their production costs. Lower tariff helps firm to promote structural changes and also improves efficiency. Moreover, due to reduced tariff, the cost of importing business equipments and material also becomes cheaper that leads to lower cost of production for various manufacturing firms (Sloman, et al., 2013). Therefore, reduced production cost through reduced tariffs helps to decrease cost inflation in Australia.
Taxes are defined as production costs for business, which leads to charge more by the firm for their production. Therefore, higher level of company taxes leads to greater level of cost inflation in the country. For cutting the higher tax rates, Australian government introduced tax reforms for controlling the rate of company tax. In this regard, it was also proposed to reduce the tax rate to 28.5% from July, 2015 which will encourage companies to increase their incomes by expanding their operations. In addition to this, low tax rate leads to effective after tax profit generation for the firms, which leads to selling of goods and services at lower prices (Anderson, 2012). Finally, it leads to lowering the rate of inflation in the country and also helps local firms to be more competitive and effective globally.
National Infrastructure projects includes construction of roads, railways, port facilities, power and water grids and communication system that are effectively helpful for business in producing other goods and services. Therefore, the Australian Federal Government introduced new infrastructure projects like rail links, national highways and National Broadband Network (NBN). Improved rail and road transport structure plays an effective role in bringing efficiency, reducing travelling time in providing raw material to manufacturers and finish goods to wholesalers/ retailers that will effectively help to reduce production cost for the firms. Additionally, NBN helps to improve and maintain the speed of telecommunications that effectively helps to reduces cost. Ultimately, the reduced cost helps to promote low inflation environment in Australia as it further helps in reducing the cost of inputs that goes into production of different goods and services.
Conclusion
From the above discussion it can be concluded that inflation affects the economy of Australia. The inflation rate in Australia has been fluctuation. However, since last two years, the economy is facing low levels of inflation that is lower than its benchmark range of 2-3%. It is also concluded that in year 2011 the inflation rate was 3.33%, which is very high as compared to other years. It is assessed that there are many reasons that impacted on the inflation rate in 2011 such as flood in Australia that damaged the crops of farmers. Due to this, the price of vegetables and fruits had increased. In 2013 and 2014, the inflation rate was moderate reason being the boom in mining industry of Australia that increases the purchasing power of households. At the same time it is also concluded that the Reserve Bank of Australia has adopted certain monetary and fiscal policy measures to increase the inflation rate to required levels. In this context, it was assessed that the government has adopted expansionary monetary policy by reducing the cash rate to 1.50% to increase the supply of money in the economy. Additionally, its fiscal policy measures include reducing in tax rates, corporate tax rates and tariff rates and increase in government expenditure to promote economic activity in the economy.
References
Anderson, K. (2012) Australia’s Economy in Its International Context. Australia: University of Adelaide Press.
Australian Bureau of Statistics (2016) Consumer price index, Australia. [Online]. Available at: https://www.abs.gov.au/ausstats/[email protected]/mf/6401.0 (Accessed: 19 September, 2016)
Blanchard, O., and Sheen, J. (2013) Macroeconomics. Australia: Pearson Higher Education.
Enright, M., and Petty, R. (2016) Australia’s Competitiveness: From Lucky Country to Competitive Country. Australia: John Wiley & Sons.
Finch, N. (2012) Contemporary Issues in Mining: Leading Practice in Australia. UK; Palgrave Macmillan.
Hubbard, G., Garnett, Anne., Lewis, P. ,and O’ Brien (2014) Macroeconomics. Australia: Pearson.
Inflationdata.com (2016) Annual Inflation. [Online]. Available at: https://inflationdata.com/Inflation/Inflation/AnnualInflation.asp (Accessed: 19 September, 2016)
Inflationdata.com (2016) Inflation was Up Slightly in January 2014. [Online]. Available at: https://inflationdata.com/articles/2014/02/20/inflation-january-2014/%E2%80%8E (Accessed: 19 September, 2016)
McTaggart, D., Findlay, C., and Parkin, M. (2012) Macroeconomics. Australia: Pearson Higher Education.
Morris, R.M.., (2014) Economics Down Under Book 1 VCE Economics Units 1 and 2 9E and EBookPLUS, Book 1. Australia: John Wiley and Sons.
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Statista (2016) Australia: Inflation rate from 2010 to 2020. [Online]. Available at: https://www.statista.com/statistics/271845/inflation-rate-in-australia/ (Accessed: 19 September, 2016)
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