Inflation

Question 1

Intro (def, stats)

Answer 1

Target inflation 2-3%
Headline inflation 7%
Trimmed mean 6.6%
Weighted median 5.8%

Question 2

P1(cause 1: COVID)

Answer 2

Demand pull
* Alongside ^ u/e and reduced AD, covid made firms actively reduce prices to match demand levels.
* Demand-pull deflation diagram!!
* Was shown with the -6.0% e/g and 7.5% u/e coinciding with -0.3% inflation Jun 2020

Question 3

P2 (cause 2: fuel, electricity)

Answer 3

2021-2023 (Cost Push & Imported Inflation)
* Increase in fuel and electricity prices because of Russia/Ukraine war and OPEC (controls 30% of oil supply) supply cuts in Oct 2022
* ^ in M$ as Aus doesn’t produce these inputs -> ^ M-inflation and ^ in c-push inflation.
* Passed on by firms to maintain profit
* COST PUSH INFLATION DIAGRAM
* From Dec 21 to Dec 22, electricity prices increased by 8.6%, leading to headline inflation of 7.8% in Dec 22.

• Disruption to global supply chains
• Worker shortages
• Inflationary expectations

Question 4

causes of inflation

Answer 4

1. Demand pull (graph)
2. Cost push (graph)
3. Inflationary expectations
4. Imported inflation
5. Government policies - taxes (eg. GST), regulate industries, tariff rates
6. Increases in monetary supply

Question 5

costs of inflation (x7)

Answer 5

1. Erodes purchasing power
2. Uncertainty in investment
3. Income redistribution - erodes the real value of debts (borrowers benefit, lenders lose), fixed income earners (eg. pensioners) lose
4. International competitiveness
5. “Menu costs” - firms face costs in adjusting prices in response to inflation
6. Wage-price spiral - workers demand higher wages
7. Erodes savings

Question 6

benefits of inflation (x1)

Answer 6

It isn’t deflation - falling prices gives an incentive to delay purchases → decrease consumption
Borrowing less attractive → less investment, less consumption
Hiring more workers more attractive (if nominal wages stay the same and real wages rise)

Question 7

P3 (impact on DOI, impact 3)

Answer 7

• High inflations tend to negatively impact low earners more because incomes rise slower than prices rise -> this applies for Ind w incomes that are not indexed to inflation, which is especially the case for many non-salaried jobs
• Also increase the COL for those holding debt, which is especially low income earners + asset price inflation increases disparity between those with high levels of wealth and those with low levels of wealth accumulation
• 2014-17 = extreme growth in Aust. Real estate market

Question 8

P4 (impact on EG and u/e, impact 2)

Answer 8

• constraint on e/g
• Distorts S/I decisions
• High inflation discourages business investment because it makes producers uncertain about future prices + costs = theoretically more likely to spend and not save during periods of high inflation
• BUT: not consistent w Australia’s experience during the 1990s as low inflation did not increase the household savings ratio
• (PHILIPS CURVE) short term: inflation increase = unemployment decrease Long term = no trade off between inflation and unemployment in long run -> u/e will eventually shift back to the natural rate

Question 9

P5 (impact on external stability, impact 4)

Answer 9

Worsens a CAD: high inflation = increased prices for Aust X = reduce international competitiveness (relative interest rate differential)
more likely to switch to impromptus too

Question 10

P6 (wage price spiral, impact 6)

Answer 10

• consent low inflation enables price stability (: -> businesses and consumers can make LT decisions as future prices and costs remain predictable = greater investment and long term e/g
• Deflation very bad -> lead to wage spiral as consumers and businesses delay purchases for consumption and investment expecting prices to continue to fall
• Deflation can also signal poor economic performance in an economy, discouraging I particularly from foreign investors
• It results in decreased revenue for businesses, causing falling wages and increasing unemployment = WAGE SPIRAL
• It also means that debt value increases as there is a greater opportunity cost between paying debt obligations and satisfying ones needs and wants by purchasing goods/services

Question 11

P7 (monetary policy)

Answer 11

• EXPLAIN - ie when inflation increase, then contractionary monetary policy, etc
• Specifically talk about the 2022 hikes from April (0.25%) to December (3.10%) which attempted to decrease inflation
• LIMITATION: thsi decreased economic growth to 2.7% (way too strong because that’s below 3-4% growth target) and was ineffective because December 2022 inflation was 7.8%
• That’s due to cost-push inflation resulting from complications in china-australia supply chains

Monetary policy is pre-emptive

Question 12

P8 (fiscal policy)

Answer 12

• Inflation is not a primary focus, so fiscal policy focuses on cost of living relief.
• Fuel excise from 44.2 to 22.1c per litre to reduce price of transport (2022-23) BUT this led to increased d-pull inflation. 3% in september 21 to 7.8% in dec 2022.
• Because this wasn’t that effective the govt decided to focus on energy bill relief (6bn, which works with utility providers to decrease autonomous consumption AT SOURCE.) less likely to promote consumption.
• inflation is thus expected to fall. Potential effectiveness.

Fiscal policy → rising inflation → reduce govt spending → reduce demand pressures → decrease demand pull
Decrease in protection