Q/Define the term “Inflation” and discuss its economic effects and also outline the role of the Reserve Bank of Australia (RBA) and the Federal Govt in trying to control inflation.
One of the most important economic concepts is inflation. At its most basic level, inflation is simply a rise in prices. Over time, it increases the costs of goods and services and due to that the value of a dollar goes down because you are not able to purchase as much with that dollar as you could have before.
Generally rising price levels lead to uncertainty over future economic conditions; this has different impacts on the economy, and different impacts for businesses and individuals as well on borrowers and lenders.
• Workers who have market power and are able to increase their wages in line with the rising price level and therefore protect their purchasing power of their incomes, benefit from inflation, and when the purchasing power of their income falls and their incomes do not keep pace with the rate of inflation, then they lose out from inflation
• Individuals who have fixed interest investments will lose out as the real rate of return from rising price levels.
Economic Effects of Inflation
Inflation can and does have very serious consequences for all sectors of the economy. As well, some people suffer more in times of inflation than other, as explained below:
1. Wage Rates: For workers whose main incomes do not keep up with rising prices, their real income decreases. Consequently, in spite of having higher income, their livings standards do not improve.
2. Fixed Incomes: People on fixed incomes, such as social welfare recipients or retirees with superannuation, find their incomes increase slowly. Their standard of living may fall because they are no longer able to afford the same level of goods and services.
3. Business profits: Inflation creates uncertainty. People do not know whether to spend or save. Some businesses may sell less while others may sell more. Should businesses expand now and be ready for the future or should they reduce production? If the Reserve Bank increases interest rates to control inflation, businesses may be reluctant to borrow and may shelve plans for expansion. Ultimately, this may result in a recession and as a result business profits fall.
4. Savers and investors: Inflation makes it difficult to maintain financial security. This is because, if the CPI increases by 8 per cent in a year, but average interest rates paid on deposits are only 5 per cent, the money in savings accounts, superannuation funds and managed funds decreases in value. If inflation is expected to remain high, saving may be discouraged.
Role of the Reserve Bank of Australia (RBA):
The Reserve Bank of Australia is Australia’s central bank, a statutory authority established by an Act of Parliament, the Reserve Bank Act 1959, which gives it specific powers and obligations.
RBA conducts the economic policy by maintaining a strong financial system and states the nation’s currency. As well as being a policy-making body, the Reserve Bank provides selected banking and registry services to a range of Australian government agencies and to a number of overseas central banks and official institutions. It