3.2 Part 3: Recent trends & influences on Australia’s inflation rate and living standards

Trends
1. 2009-10 to 2012-13 our average inflation was 2.5%. This is within the RBA’s target and significantly lower than the 3% average held years before.
2. Changes in the inflation rate partially followed a cyclical pattern and moved up and down in variations.
Recent influences on Australia’s inflation rate and living standards
1. Demand and Supply side factors originating here and overseas have affected the inflation rate of Australia in recent years to 2013.
The influence of recent demand side conditions on demand inflation
1. Demand inflation - typically occurs in a boom when spending (demand) outstrips production (supply) and there are widespread shortages of goods and services.
2. Moves up and down to reflect changes in the cyclical level of AD.
  1. up when AD is strong and running ahead of production AS. Productive Capacity reached
    1. prices are pushed up by falling stock levels and shortages of goods and services. This weakens our purchasing power and living standards
3. Demand inflation can ease when spending is less than production. Slows down economic activity with rising stocks due to falling sales leading to lower prices to try and get rid of stock.
4. Lower prices improve our purchasing power and living standards.
5. 2013 Australia’s demand inflation varied. Early 2008, we near boom resulting in demand pressures. Strong spending originated both locally and internationally and together this caused AD to expand as we were near productive capacity.
6. GFC in late 2008-09, slowed down in spending on all products. To clear excess stock, prices were dramatically reduced. Slowed inflation before the demand pressure started to build up again.
7. A number of aggregate demand factors explain these trends in demand inflation.
  1. Changes in consumer Confidence and disposable income
  2. Changes in the level of overseas economic activity and our terms of trade
  3. Changes in the exchange rate for the Australian dollar.
  4. Changes in interest rates and monetary policy set by the Reserve Bank of Australia (RBA)
  5. Changes in government budgetary policy stance
  6. Using the AD-AS diagram to show the effects of changing demand side conditions.
Changes in consumer Confidence and disposable income
1. Consumer confidence can alter the amount households spend and sae, AD, retail sales and stocks sold by firms
2. disposable income and confidence is high and it appears that spending is exceed production, demand inflation is accelerates. There were signs of this in mid 2008 before the GFC.
3. following the GFC demand pressures on inflation diminished as confidence came to a low. This caused incomes to be saved rather than spent, shortages on goods and services and sellers decreasing prices to try and get rid of excess stock.
Changes in the level of overseas economic activity and our terms of trade
1. Very strong economic activity overseas among our major trading partners is an aggregate demand side factor that can accelerate our export sales and AD. If this occurs there is limited unused capacity leading to general shortages of goods and services because of rapid growth
  1. early 2008 this occurred when all of our trading partners were demanding big loads of commodities which caused our trade index to reach an all time high. This pushed up our exports, AD and inflation because there was limited unused productive capacity available.
2. result of the GFC and recessions abroad, spending on exports fell. This led to a rise in stocks, reduced shortages and price discounting. During this time Australia’s inflation rate was at 1.4% to encourage people to spend money.
Changes in the exchange rate for the Australian dollar.
1. 2008-09 the dollar grew by 20%. The rise reduced demand and inflation pressures as it slowed spending on exports as they became dearer abroad.We purchased more home grown products keeping the money circulated in our country.
2. collapse of the Australian dollar in late 2008 helped lift our export values and depressed imports. This boosted AD, cutting stocks and putting upward pressure on prices.
Changes in interest rates and monetary policy set by the Reserve Bank of Australia (RBA)
1. Interest rates can be a demand factor which affects the inflation rate due to levels of saving, credit, AD and economic activity.
2. Low interest rates set by the RBA in 2008-09 tended to accelerate demand inflation pressures by discouraging savings and encouraging borrowing.
3. limited productive capacity available this can lead to higher levels of AD or spending which leads to shortages of goods and services, adding to demand inflation pressures.
4. RBA raises interest rates like in 2009-10 it slows down the level of economic activity. Stocks rise, price discounting is encouraged and there is reduced demand inflation pressures.
Changes in government budgetary policy stance
1. Budgetary policies look at changes in the governments receipts and outlays (amount of money received and spent) for the upcoming year.
2. Inflation rates affect stance of the government, whether it is contractionary (slow AD) or expansionary (raise AD)
3. During the GFC there were major budget deficits (value of government outlays exceeds the value of government revenue in a given year). Designed to boost spending and add to demand inflation to get through to economic recovery.
4. budget surplus would tend to slow spending and economic activity easing the pressure of demand inflation.
Using the AD-AS diagram to show the effects of changing demand side conditions.
1. Persistently strong demand side conditions cause the level of spending on Aus made goods and services to become excessive and rise beyond the productive capacity. Happened a few years before mid 2008. Demand inflation rose in response to shortages caused by the economy when using up its spare productive capacity.
2. Weaker demand side conditions in 2008-09 helped to slow expenditure, easing general shortages of goods and services, promoting price discounting.

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3.2 Part 3: Recent trends & influences on Australia’s inflation rate and living standards

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