Inflation In Australia: Causes, Effects, And Government Policy

Discussion

Discuss about the Economics for Business Statistics.

Inflation is generally regarded as an illness for the economy that harms the materialistic living standard of peoples in a country. It refers to a continuous increase in the price level for the commodities and services in an economy over a period of time.  It implies the rise in the average prices of all the commodities and services in an economy over a certain period of time. On the contrary, if the opposite happens, i.e. continuous fall in price level of the goods and services of an economy, it is termed as deflation.

Inflation generally takes place during the period of boom when the economy is producing more than its productive capacity and there is a widespread shortage of goods and services. In contrast, deflation occurs when there is recession in an economy and there has been over production with excess supply of goods and services and less of income, demand and consumption (Dawkins and Wooden 2010).

In the paper, the inflation of Australia has been studied for last five years and government policies to control inflation are analyzed and discussed. The paper takes the clue on Australian economy inflationary situation from several articles related to the topic. The articles discussed here are “Australia joining low inflation world” by Stephen Letts, “Inflation in Australia: Causes, Inertia and Policy” by Fahrer and Myatt, “Inflation Targeting: A Decade of Australian Experience” by GR Stevens and “Dollar goes bananas on rising inflation” by Michael Janda. Another article discussed is  “Understanding the appreciation of the Australian dollar and its policy implication” by Garton, Gaudry and Wilcox.

The paper tries to understand the inflationary situation of Australia and its impact on the economy through the study of the articles mentioned here and through research on the government policies towards controlling inflation.

Inflation is an important indicator for economic performance of a country. Like all countries, Australia also has a record of worst inflation over the years. The worst inflation were during World War I in 1918-19, Korean War boom in 1950-52, first global crisis in 1973-77, rapid wage rise in 1979-83 and during the time of introduction of GST in 2000-01. Overall, between 1990 and 2013-14, the inflation rate in Australia was relatively slow. The calculation of inflation rate is done in every quarter by the ABS with the use of consumer price index that measures the average change in the retail price of a basket of imported and local commodities and services that indicates the expenditure of the households (Rushdi et al. 2012).

Factors Affecting Inflation in Australia

The general trend of inflation in Australia was averaged to be at 3% each year from 2000 to 2014. One of the key aims of Australian government is to achieve low inflation rate to 2-3% a year (rba.gov.au 2016). Inflation rate above this would weaken the major aspects of economic performance, like competition in the international market, distribution of income and others.  On the other hand, inflation rate below it would mean slow economic growth and indicates that that are under-utilized resources in the economy and the country’s productivity capacity is wasted (Pissarides 2011).

In late 1990s and 2000-01, inflation has strengthened with the introduction of GST, sharp rising in oil prices and depreciation of Australian currency. In 2001-02 and 2004-05, the inflation rate was moderately slow and to 2-3%. However, during 2005-06 and 2007-08, inflation rates were comparatively higher to 3.5%, above the target rate of government. Such a rate indicates that the economy is operating near its productivity capacity. In 2008-09, the inflation rate has decreased to 2-8% due to Global Financial Crises (rba.gov.au 2016). It is required to hold low inflation rate in Australia to safeguard the purchasing power of the incomes and to strengthen the competitive position in the international trade.( Parkin 2012)

The factors that affect inflation in Australia can be divided into parts. One, due to extreme strong demand side conditions called as demand inflation and second, cost inflation caused due to less favourable supply side developments.

The demand side factors affect the aggregate demand of the economy and results in too much spending chasing too few Australian goods and services. In other words, aggregate demand will exceed aggregate supply, and price will start rising and causing demand inflation. The reason behind increasing spending in the country may be due to increasing confidence of consumers and business-man in the economy leading to reducing their savings and increasing their investment and spending. The increase in household stimulates consumption spending income and export has increased due to good relations with the international trading partners. Further low interest rate on credits encourage the consumers to enhance their spending and the expansionary budget of Australia has reduced the tax rates and increase the spending of the government and people (Phipps 2011).

The supply side factors that lead to cost inflation are rising production cost due to hike in wages paid to the workers, reduction in the productivity of labour or efficiency, less producer’s competition between goods and services due to collusion among them and existence of monopoly or oligopoly market structure and higher interest rate on the finance borrowed for the purchase of plants and machineries in the production sector. Other reasons for cost inflation in Australia are, increase in taxes like excise tax, removal of subsidies on inputs and rising taxes on imports of inputs, rising oil prices and severe climatic conditions that affect the production and supply of fruits, vegetables and meat, leading to rise in their prices (Brouwer and Ericsson 2012).

Cost Inflation

It is noted that demand inflation takes place during boom period but cost inflation can take place in any economic situation. The government of Australia, has been able to control cost inflation by reducing the tariff rates, increasing the productivity of workers by adoption of modern technology, strengthening the value of Australian dollar to keep the price of import low, adopting market policies to increase competition in the market that drives the price down and other microeconomic policies introduced by the government. Further, the global recession of 2008-09 has caused the cost inflation to reduce due to fall in wages, interest rates and reduction in the prices of raw materials. However I 2011 and 2014 the hike in the price of imported goods and crude oil has again caused rise in cost inflation (Laidler and Parkin 2012).

The government of Australia has adopted several aggregate demand policies and aggregate supply policies to control demand and cost inflation. The federal government has used budgetary measures and contractionary monetary policies to reduce the excess level of spending by the people or to curb the rise in aggregate demand (Svensson 2012). The Reserve Bank of Australia through their monetary policy has changed the interest rate in a manner to reduce the spending in the country. The interest rates were increased in the period 2002-08 and 2009-10 so that the people are attracted to save more of their liquid money than to spend to reduce demand inflation. Further, increase in credit cost discourages consumption and investment expenditure and reduces economic activity and aggregate demand (Valadkhani and Layton 2012).          

The government of Australia has adopted contractionary budgetary policies to curb inflation. It involves increase in taxes and reduction in government expenses. In 2008 and in 2016, government has switched to contractionary budgetary policy to slow its expenditure and increase its revenue collected through taxes from individuals and companies and reducing government expenses or outlays. It results in reduction of private consumption, private investment, government spending and hence aggregate demand. As the spending reduces, the inventory stocks starts increasing and shortages gets reduced, thus stops demand inflation (Mallik and Chowdhury 2011).

The government of Australia has used microeconomics or supply-side policies to curb cost inflation. These are efficiency promoting and cost-cutting measures which help the people to produce more output from less resource. The tariff protections were reduced in some of the sectors to force the manufacturing firms to find new ways of reducing production cost through technological innovation. Moreover, in 2000, 2005 and 2010, tariff rates for textile, cars, footwear and clothing were reduced (rba.gov.au 2016). It has encouraged firms for increasing the efficiency of production and reducing the production cost and to accelerate the structural change. Furthermore, lower production cost for business people was achieved in Australia by lowering the cost of imports on some business equipment and materials and hence allowing them to sell goods at a profitable price. It has further benefitted the Australian consumer with lower prices of goods and services (Hossain 2014).

Demand Inflation

The Australian government had set minimum wages which has increased the labour cost and has been a reason to raise inflation. Keeping this in mind, the labour market reforms was introduced which involved workplace agreement or enterprise bargaining that made possible the negotiation between the boss and the employees on firm-by-firm basis. The labour market reforms was introduced in 1991 and by 2012, around 85% of the workers in Australia were covered by enterprise agreement (rba.gov.au 2016) The process has helped in reducing cost inflation but wage level of workers was no more uniform and the rise in wage was used more as the incentives for the workers to increase their efficiency or productivity. In 2002, Australia’s labour efficiency has increased and cost inflation has reduced due to use of enterprise bargaining policy. However, in 2004-05 and 2010-11, there was reduction in the growth of labour productivity leading to inflationary pressures (Dwyer and Leong 2012).

Other policies adopted by the Australian government to reduce inflation were to encourage migration of skilled workers that lowered the cost of wage, to encourage training and education of workers for lifting the efficiency and reducing the cost, adaptation of national infrastructure projects and competitive policies to reduce cost of production and lowering the company tax to reduce production costs (Basse 2012).

The article “Australia joining low inflation world” discusses the reasons why Australia has been able to keep low inflation over a period of time. Some of the reasons were discussed as key drivers for a low inflation. They were lowering the prices of clothing, communication, health and general insurance, utility commodities, public transportation and wages. The new entrant in the market of clothing like, Zara, Uniqlo and others have put downward pressure in the prices to capture the market share and hence prices in clothing ha reduced by 0.5 to 1% (Debelle and Stevens 2011). The huge competition in the telecommunication industry has drove down the price of mobile and data cables by 1 to 2% and reduced inflation to negative numbers in the sector. The competition in the insurance industry due to huge entry of new entrants has reduced the price of general and health insurance and has brought the inflation down by 2% in this sector. Further, in utilities item, inflation was controlled by stronger regulation and has brought down to 4 %. In public transportation, inflation was controlled by combination of restructuring models and political pressure and was brought down by half. Lastly, Australia was able to rebalance away from high wage job to low wage job and was able to  put downward pressure on labour income growth. It has led to disinflationary situations in non-tadable sectors like service industries (ABC News 2011). 

Government Policies to Control Inflation

A research discussion paper on “Inflation in Australia: causes, inertia and policy” have examined the determination of inflation in Australia and other developed nations, like United States, Japan, New Zealand and United Kingdom. It has tried to observe the rate at which inflation deviates from its equilibrium point which they have defines as degree of inertia. The paper states that fundamental cause of inflation has been higher growth in nominal wage rate than the rate of growth on money (Valadkhani and Layton 2012).  The paper has suggested Australia to reduce inflation by adopting the policy of lowering the aggregate nominal wage growth. It can be adopted by deregulation of the labour market that makes the wage determined by the organization itself and helps the organization to take efficiency enhancing measures through wage changing policies. The paper also suggested Australian government to adopt monetary policy to lower inflation through demand side measures (rba.gov.au 2016).

The article “Inflation Targeting: A Decade of Australian Experience” has discussed the monetary policy of Australia and concluded that the government was successful in lowering the inflation rate over the period through prudent monetary policy. The economy of Australia has grown in a much better way with less variation and controlled inflation (Ryan and Thompson 2011). The article states that the government policy towards controlling inflation has made a major contribution to economic growth. Targeting inflation control policy leads to short-term flexibility in the decisions of monetary policy and also imposes the required medium-term constraints. The paper suggests that it will be a continuous task of the government to tackle the cyclical fluctuations and shocks in the economy. Along with it, the government need to tackle the swings in the asset prices (rba.gov.au 2016)

The article “Dollar goes bananas on rising inflation” discusses the surge in the dollar price leading to inflationary position in Australia. The rise in necessity items were further increased due to rise in dollar price in the international market To name some items, the price of fruits, vegetables, furniture have increased due to appreciation of dollar in international market. The article suggests government to adopt several policies to control the effect on domestic price due to the rise in international price. The Reserve bank of Australia should control the currency value of dollar in the international market so that the value of dollar in the domestic market remains stable and does not cause inflationary situations (ABC News 2011). 

Monetary Policy

An article on “Understanding the appreciation of the Australian dollar and its policy implication” explains the appreciation of dollar in the international market and reduction in the exchange rate. The lower exchange rate implies higher value of its currency and lower prices which leads to low inflation rates. The article discuses the different drivers that cause the appreciation of currency in the international market. It suggests the government to adopt policies that push the drivers and lead to appreciate the currency in the international market. Such a step by the government will help in controlling inflation in the domestic market (ABC News 2016).

Inflation is a major issue in several countries and most of the government policies are highlighted towards controlling inflation. The article discussed here are the examples of how inflation in a country has become a major part of government fiscal and monetary policy of any country. The fiscal and monetary policy are the two pillars of government and monetary authority policy makers through which they try to control the major indicators of the economic growth in the country. The steps in fiscal policy to control inflation are generally by making policies towards taxation to curb consumption and investment and providing cheaper production pattern by giving access to advanced technology adoption (Debelle et al. 2012). Further fiscal policy also aims to build infrastructure that does not encourage inflationary pressure, create competitive market to lower the market price of the goods and services produced by the competitive firms. Other fiscal measures can be to develop skilled labour force by enhancing education and training system of the country, removing poverty and income inequalities of the country and making the determination of wages for the organization competitive, i.e. making the labour market, a competitive market rather than minimum or maximum wage slabs in the market that raises the production cost and leads to cost inflation in the country (Basse 2012)

The monetary policy can be to increase interest rate, repo rates; cash reserve ratio and statutory liquidity ratio in order to curb inflation. The rise in any of the above will reduce the amount of loanable money with the banks and will lead to lower credit creation in the economy that will generate lower money supply and hence leave less money in people’s hand to spend in the market. In this way the expenditures by the consumers, producers and government can be controlled through monetary policy (Ryan and Thompson 2011). Further, to stabilize the value of the currency, open market operations are adopted through which the Central Bank of the country sale and purchase currencies in the market on daily basis to control the exchange rate of the currency against any other currency in the international market. It helps to control the value of the currency in the domestic market and hence control inflationary pressures (Banerjee and Russell  2012).

Contractionary Budgetary Policies

Conclusion

In conclusion the brief of the paper is given. The paper discusses the study on Inflation in Australia for the past years and understanding the government policy on inflation. The paper discusses several articles on inflation and government policy towards controlling inflation.The articles discussed here are “Australia joining low inflation world” by Stephen Letts, “Inflation in Australia: Causes, Inertia and Policy” by Fahrer and Myatt, “Inflation Targeting: A Decade of Australian Experience” by GR Stevens and “Dollar goes bananas on rising inflation” by Michael Janda. Another article discussed is “Understanding the appreciation of the Australian dollar and its policy implication” by Garton, Gaudry and Wilcox.

Each of the articles highlights the problem of inflation in Australia and the measures government should take to control it. They mention the positive and negative effect of inflation in different sector and government policies to act promptly to control inflation. The paper also explains the cycle of inflation over the period and how government has taken several steps and measures to control inflationary movements. The Australian government has been more or less successful in controlling inflation and is on the way to achieve the targeted low inflation rate of 2 to 3 percent. Australian federal government and Reserve Bank of Australia have taken timely measures and necessary steps to curb inflationary movement in different sectors and stabilize the growth and development process.

References

ABC News. 2011. Dollar goes bananas on rising inflation. [online] Available at: https://www.abc.net.au/news/2011-07-27/inflation-above-expectations-dollar/2812512 [Accessed 5 Jun. 2016].

ABC News. 2016. Australia joining low inflation world. [online] Available at: https://www.abc.net.au/news/2016-04-29/australia-joining-low-inflation-world/7372032 [Accessed 5 Jun. 2016].

Anon, 2016. [online] Available at: https://www.rba.gov.au/ [Accessed 5 Jun. 2016].

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