Question:
Compare Australia with any other country from the list which includes Germany, UK, USA,China, India, Japan, Korea, Indonesia and discuss inflation and causes of inflation and the various governments policy on inflation.
Answer:
Inflation is a global phenomenon. There is no country in the capitalist world that is not hit or affected by its spectre. In general parlance, ‘Inflation’ is a sustained increase in the general price level of goods and services in an economy over a period of time. It represents a decrease in the purchasing power of each unit of the currency and leads its spenders onto affording fewer goods and services. Inflation is measured through ‘inflation rate’, which signifies the annual percentage change in the consumer price index of the country.
In world economy, Australia and India are forces to be reckoned with. While India is the world's seventh-largest country in terms of nominal GDP, Australia is known as one of the world’s largest mixed market economies with a GDP of AUD$1.62 trillion, till the year 2015. Driven by mutual interests and ties, the two countries have had a total bilateral trade worth US$18.7 billion, as of 2010, which is expected to rise to US$40 billion by end of 2016. India and Australia generally have a warm relationship, with shared political, economic, security, lingual and sporting ties.
However, despite such a strong stature, both nations have been unable to escape the claws of inflation. For Australia, inflation has typically been 2–3% and the base interest rate 5–6%. From the mid-1950’s to late 1960s, inflation was relatively low. Owing to high oil prices, wage increase and various policy reforms, the Australian economy suffered a sharp inflationary pressure from the early 1970s to 1980s. By 1990s, the rates slowed down and Australia greeted the 2000s with a stable inflationary rate of around 3%. Apart from the only significant change witnessed by the country in its inflationary rates during the taxation reforms of the early 2000s, Australia has enjoyed a relatively stable inflationary ground.
On the other hand, the Indian economy has been caught in a high-inflation trap. At present, the annualised inflation rate in India is 3.78% as of August 2015, as per the Indian Ministry of Statistics and Programme Implementation. During the 1990s and early 2000s, inflation in India exhibited a relatively better standing than other emerging economies. After being low for a decade, it rose rapidly to even touch 10-11 percent in the year 2008 and continued to stay high. Prices of necessaries, especially food items, had almost doubled in the year 2013, as compared to 2007.
A higher rate distorts and stunts the free flow of demand and supply in the market. High inflation also leads to a wage-price inflationary spiral, uneven and inconsistent distribution of income, increase in the rate of unemployment, international competitiveness, and a severe impact upon the exchange rate. Inflation is one of the major constraints for economic growth, and has a significant and severe impact on both Australia and India alike.
Factors Influencing Inflation
There are various factors in Australia and India that influence their inflationary rates. While some factors are common between the two, other causes are geographically centric and domestically exclusive. At the core, inflation is usually caused by demand-supply gap. World economies, however, mostly face situations of Demand-Pull Inflation and Cost-Pull Inflation. These theories, as propounded under the Keynesian economics, have been elucidated with reference to Australia and India.
I. Causes of Inflation in Australia
The Australian inflationary rate is affected by two main types of factors, which are:
An increase in aggregate demand, or any demand-side factors, leads to a surge in the number of consumers chasing a limited number of Australian-made goods and services. In simpler words, the Aggregate Demand (AD) will exceed the Aggregate Supply (AS) of the goods and services in the Australian economy. Thus, when national production fails to meet the national spending, the consumers will bid against each other to acquire the limited supply of goods, which will lead to an increase in general price level of goods and services. The demand curve is forced to shift to the right from AD1 to AD2 while the supply curve remains stationary at AS, causing pressure upon price of goods to increase from PL1 to PL2.
Such surge in prices caused solely by demand factors is known as demand inflation. Such a situation is commonly referred to as a ‘boom’. Australia has often experienced such bursts of demand inflation, for instance, the Korean War boom (early 1950s), the late 1980s, between 2005 and mid-2008 and to a lesser extent, during 2010–11. A leading example in Australia for demand-pull inflation has been its real estate market. In the early 2000s, there was a rapid increase in the demand for houses, which led to more consumers chasing a limited supply of houses in a short period of time.
Illustrations of the aforementioned demand-side factors that cause demand inflation are:
A rapid increase in Australian household income that raises private consumption boosts
the demand for products.
Better economic conditions of the trading partners of Australia, which enables them to purchase more of Australian-made products.
An expansionary budgetary scheme (for instance, a budget deficit) that provides for lower tax rates or higher spending by the government leads to an increase in the overall expenditure, causing an inflationary pull.
Lower interest rates on credit which stimulates the amount of borrowings by households and business. Such borrowings are generally used to finance private consumption and investment expenditure, causing an increase in the aggregate demand.
Reduction in the amount of savings by households and indulging in unusual spending. Similar notion is adopted in case of businesses when they expand the scale of their organization and increase their investment. Such activities on a mass scale increases the flow of money in the economy, leading to higher demand for goods.
To curb demand inflation, it is pertinent to weaken the demand-side conditions. In Australia, it was done by way of lowering the growth in spending in the year 2008-09, and by forcing the economy to go into recession in 2008–09 or 2010–11. The sudden drop in the rate of expenditure leads to overproduction and an increase in the stock of unsold commodities. To clear this stock, producers lower the prices of goods and services to pull the demand up to the supply. The lowering of prices, thus, reduces demand inflation.
Cost inflation occurs when rising production costs cause firms to put up their final selling prices in order to protect their profit margins. Cost inflation can occur in any economic condition, even when there is high unemployment. The most common supply-side factors that cause rising production costs or cost inflation are: