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Inflation - a continuous upward movement in the general level of prices - can impose costs on individuals and the economy. Inflation reduces the purchasing power of income and wealth.
When price changes are large, unanticipated or volatile, inefficiencies can occur such as those associated with frequently changing list prices in shops or re-advertising of goods and services (inefficiencies known as 'menu costs'). Frequently changing rates of inflation can also distort the behaviour of consumers and businesses, who may find it more difficult to predict the effects of their saving and investment decisions.
Although inflation is defined as a rise in the general level of prices, not all prices change by the same proportion or in the same direction. For this reason, inflation can also affect the distribution of real income and wealth among individuals and households. A relatively steep increase in the prices of items that make up a large part of low income households. expenditure, for example, can cause greater inequality in the distribution of real household income.(SEE FOOTNOTE 1)
Some changes in relative prices can have positive effects as well as the negative effects discussed above, and many economists are of the view that zero inflation might be undesirable. Changes in relative prices can act as a signal during times of economic restructuring. This restructuring could be brought about by, say, changes in tastes and technology, and could in turn lead to resources being allocated more efficiently.
Ideally, an indicator of overall inflation would be comprehensive - it would cover price changes for all goods and services traded in the economy. But different measures of price change are suited to analysing different economic phenomena. Because of the different possibilities for weighting together the prices of various goods and services, there is no single correct measure of inflation.
TRENDS IN INFLATION - 1990 TO 2001
A commonly quoted indicator of inflation is the rate of change in the Consumer Price Index (CPI), which reflects the price of a fixed basket of goods and services consumed by households. Other important indicators include the national accounts chain price index for Domestic Final Demand (DFD), and the (currently experimental) price index of Domestic Final Purchases (DFP). Both the DFD and DFP price indexes are more comprehensive than the CPI because they cover purchases by businesses and government as well as households.
The DFP index is currently being developed by the ABS as a preferred measure of inflation: it is both more comprehensive and aligned more closely to market transactions. Unlike the DFD index, the DFP index excludes notional transactions such as imputed rent for owner-occupied dwellings, and non-market influences such as government taxes and charges paid by households.(SEE FOOTNOTE 2)
The graphs below show percentage changes in the CPI and DFD indexes for 1990-91 to 2000-01. The CPI referred to in this commentary excludes housing costs. The treatment of housing in the CPI changed significantly in September quarter 1998,(SEE FOOTNOTE 3) so the CPI exclusive of housing provides a more consistent view of inflation over time.
Aside from a rise in 1995-96, inflation was relatively stable from the early 1990s to 1999-2000. Economic growth began to slow towards the end of the decade, and inflation returned to lower levels. The introduction of The New Tax System (TNTS) saw a large increase in the CPI between June 2000 and September 2001, though underlying inflation (i.e. the inflation rate excluding volatile items and price movements due to changes in tax regimes) is thought to have stayed relatively low.
CPI, percentage change from previous year
DFD index, percentage change from previous year
TRENDS IN INFLATION - 1950 TO 2001
Inflation was relatively low in the 1950s and 1960s. The sharp rise in inflation in the first half of the 1970s was influenced by higher oil prices, wage growth and other factors. These inflationary pressures persisted into the 1980s, partly due to a second oil price shock.(SEE FOOTNOTE 4) Although at relatively high levels, inflation was fairly stable during the 1980s. It began to slow down in the early 1990s and has remained at relatively low levels.
COMPONENTS OF INFLATION
The DFD chain price index can be split into capital and consumption components (for various reasons, the consumption component does not match the coverage of the CPI exactly).
While the consumption series rose steadily between 1990-91 and 2000-01, the capital series was more volatile, and was comparatively flat during the periods 1993-94 to 1995-96 and 1996-97 to 1999-2000.
Chain price index of total final consumption expenditure(a)
Chain price index of total gross fixed capital formation(a)
FACTORS INFLUENCING CHANGE
The overall rate of inflation during the period 1990-91 and 2000-01 has been the outcome of different rates of price rises (or, in some cases, price falls) for various goods and services.
Computer prices have been declining during the decade. At the same time, there have been large increases in the power and quality of computers.
Falling world prices for motor vehicles have also contributed to lower inflation during the past decade.(SEE FOOTNOTE 5)
Petrol prices contributed to inflation during the 1990s. Fuel costs rose by 12.2% during the year ended December 1999, due to a substantial rise in the international price of crude oil.(SEE FOOTNOTE 6) At the end of the decade, high petrol prices as well as the introduction of TNTS made a large contribution to the rise in the CPI and other price indexes between June 2000 and June 2001.
House prices have fluctuated during the past decade. The first half of the 1990s saw both upward and downward movements in the prices of established houses. During the late 1990s, house prices tended on average to increase.
Some of the increases in housing expenditure during 1999 and early 2000 may have been due in part to many Australians making property purchases and alterations and additions, before the introduction of the Goods and Services Tax on 1 July 2000. This in turn may have had an upward influence on house prices during the period.
LINKS TO OTHER DIMENSIONS OF PROGRESS
Inflation is linked with almost all other indicators of economic progress. It affects the distribution of income and wealth, and hence the decisions of consumers and businesses. It also affects the external competitiveness of the economy. If rises in the prices of domestically produced goods are small relative to rises in the prices of overseas goods, Australia's international competitiveness improves, provided that nominal exchange rates do not appreciate in response. Improvements in productivity and increased competition in goods and services markets are thought to have contributed to the low inflation rates of the 1990s.(SEE FOOTNOTE 7)
1 University of Melbourne Research Paper 1996, The Distributional Effects of Inflation in Australia, University of Melbourne, Melbourne.
2 Australian Bureau of Statistics 2001, Information Paper: Price Index of Domestic Final Purchases, Cat. no. 6248.0, ABS, Canberra.
3 Australian Bureau of Statistics 1998, Information Paper: Introduction of the 13th Series Australian Consumer Price Index, Cat. no. 6454.0, ABS, Canberra.
4 Economic Planning Advisory Council 1990, Office of EPAC Seminar 1990: Australia's Inflation Problem, AGPS, Canberra.
5 Commonwealth Treasury 1999, Budget Strategy and Outlook 1999-2000, Budget Paper 1, Commonwealth of Australia, Canberra.
6 Reserve Bank of Australia 2000, The Economy and Financial Markets, RBA Bulletin, February 2000, RBA, Sydney URL: http://www.rba.gov.au/PublicationsAndResearch/Bulletin/bu_feb00/bu_0200_1.pdf last viewed 14 March 2002.
7 Reserve Bank of Australia 2000, Australian Macroeconomic Performance and Policies in the 1900s, RBA Conference Volume 2000 URL: http://www.rba.gov.au/PublicationsAndResearch/Conferences/2000/GruenStevens.pdf last viewed 14 March 2002.