Inflation and effects on Australia

Essay by louisechanCollege, UndergraduateA-, May 2004

download word file, 7 pages 3.0

Inflation is the sustained increase in the general price level in an economy. Since the mid 1990's the Australian Government has placed high priority on controlling inflation due to the negative impact it can have on our economy. It uses monetary policy, fiscal policy and microeconomic reforms to control inflation and achieve non-inflationary sustainable economic growth and low unemployment. Inflation is a restraint towards economic growth and can instil uncertainty in economic agents' view about economic conditions, which heightens inflationary expectations. It also distorts the pattern of allocation of resources by directing funds into speculative and unproductive investment (e.g. real estate) Our international competitiveness can also be eroded by high inflation as our higher priced products become less appealing to overseas buyers.

In Australia, inflation is measured quarterly using the consumer price index (CPI). This is simply a measurement of the change in the price level for a regimen of goods which are sensitive to consumption patterns.

Each good is given a different weighting according to their significance to average households. As such, the CPI gives a good indication of the overall movement in prices of consumer goods and reflects any changes in the cost of living.

There are four main causes of inflation. Firstly, demand-pull inflation occurs when aggregate demand exceeds the productive capacity of an economy. When this happens, prices rise as output cannot expand any further. Thus, consumers force prices up by bidding against each other for the limited goods and services that are available. Another main cause of inflation is cost-push inflation where costs of production rise and thus businesses pass this rise in production by raising the prices of their products. Another cause is this concept of inflation breeding inflation. The key element in this process is inflationary expectations. If inflation is expected to...