Australian inflation causes a degree of panic

There are interesting reactions to the latest inflation figures for Australia. The contribution to the Australian annual inflation rate for the last quarter (three months Jan to March) was -0.2%. In Australia this is being reported as 'deflation' and the stock market and Australian dollar both fell sharply.

As shown by the two articles below Australia is taking this news far more seriously than the rest of the world. The Guardian reports that CPI inflation has fallen to 1.3% per year, while the Australian uses the word deflation - i.e. just the change over the last three months.

Deflation is "the persistent fall in the average price level leading to a rise in the purchasing power of money" (Russell and Heathfield, Inflation and UK Monetary Policy 3/E). Clearly Australia has some way to go before it achieves deflation then. However the fear that the economy isn't doing as well as everybody thought and might be headed for recession is capturing the popular imagination.

As the data below shows there were particular classes of goods where prices fell, while other classes exhibited increases. On balance the general price level fell.

It will have to be the subject of another post to discuss the effects of deflation. The important point to note for now i that this weak inflation figure, well below the RBA target, and possibly indicating that inflation will fall further, means the RBA really should cut interest rates further. Given the time lags involved in the effect of monetary policy that means next Tuesday should see a rate cut.

The Guardian takes a detached view here

The Australian panics a bit here

The above shows how groups of goods in the CPI changed over the last three months

The Australian annual inflation rate over the last four years and the quarterly change is shown at the bottom. A falling general price level is highly unusual and may indicate a great deal of spare capacity in the economy.

This article is essential to VCE students who will need to be able to explain influences on both inflation and monetary policy.

Inflation higher

The latest inflation figure was released yesterday. This is another key variable you must follow for VCE.

For those who are new to Economics a few points of clarification.

Inflation is defined as 'a continuous rise in the general price level leading to a decline in the purchasing power of money'.

Australia only reports inflation once every three months (very unusual in world terms where usually monthly figures are reported). When reported the emphasis tends to be on how much prices rose in the three month period, for example in the latest quarter prices rose by 0.8%. But we need to focus on the annual rate - how much prices rose in the last twelve months. In this case it is 2.7%.

The figures show that annual inflation rose from 2.2% to 2.7%. This is a substantial jump, but within the target range for inflation of the Reserve Bank of Australia. However, if this jump in inflation is part of a new trend, such a move would be worrying. The chart below shows Australian headline inflation since 2008.

Looking at the figures it would appear that recently inflation over the period has settled into a stable level of 2 to 3%. We cannot tell yet if this isa new trend to higher inflation (as can be seen in earlier years), the next set of figures in April will help us to decide.

There are, however, good reasons to say we are simply observing a 'one-off' change in prices due to the weakening of the Australian dollar. The Age article below provides excellent information on this and the different measures of inflation (which we will deal with later in the course). 

The falling dollar makes imported goods more expensive and this feeds into inflation really quite quickly. However once the dollar has fallen the price of imports do not rise again, there is no 'continuous rise in the price level' which is what concerns us with inflation.

The Age article is excellent and really needs to be read. The link is here.