What Are The Causes And Policies Used To Counteract Inflation

1129 words - 5 pages

Inflation is a sustained increase in the general price level over time within an economy. It is regarded as an economic problem as it leads to a fall in the value of money or real purchasing power. Inflation is caused by demand and supply pressures, notably demand inflation, cost inflation, imported inflation and inflationary expectations. Coupled with the many negative effects that Inflation burdens on the Australian economy, the government sets about using a variety of macroeconomic and microeconomic policies to control the level of inflation within the economy. Through the continual conduct of various policies by the Government and RBA, underlying inflation had been kept at about 2.5% in 2002, within the target range of 2-3% after being between 6-10% in the 1980's.One cause of inflation within the economy is Demand inflation or otherwise known as Demand pull inflation. This is where aggregate demand exceeds Aggregate supply, causing inflation to occur as supply is not being able to meet the demand within the economy. The main causes of demand pull inflation is excessive growth in any of the major components of AD (AD= C+I+G+X-M). Increased demand leading to inflation may have been caused by increases in consumption expenditure ©, because of ↑ confidence, ↑ wages, tax cuts or falls in interest rates. Increases in investment spending may have been caused by tax cuts or increased depreciation allowances as outlined in the 2006 budget, which increases investment and causes demand pull inflation to occur. Government expenditure may increase due to a rise in Government revenue because of tax revenue, allowing the government to pursue an expansionary policy within the Australian economy. Increases in export income (X-M), may have been caused by higher investment and consumption within the domestic, causing excessive demand to occur and inflation to arise.Demand pull inflation is demonstrated in fig 9.4, shows where due to increases in real GDP from GDP1 to GDP2, demand exceeds supply, causing the price level of goods rise, causing an inflationary gap to occur at point cd on the graph.The second type of inflation, cost inflation, occurs when Aggregate Supply falls within an economy, leading inflation to occur. The fall in aggregate supply is caused by higher wage rates not related to productivity, ↑ price of raw materials, government changes within the economy and ↑ interest rates makes production more expensive thus leading to AS falling. Cost Push inflation is exemplified in figure 9.5. This shows a decrease in AS will shift the aggregate supply left to AS1, causing a new equilibrium at a higher price level of P1 to occur, and a lower output level of GDP2. The economy experiences a contraction, and due to AS falling, the price of goods rises causing Inflation to occur.The third type cause of inflation is imported inflation, where inflation occurs because of a deficiency of imports into Australia. This makes domestically...

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