Price Stability

Definition

Put simply, the Australian government aims to achieve stable prices in the economy. In fact, many economists believe that achieving price stability may by the most important of our economic goals. This is because of the way in which other measures of our economic performance react when there is a change in our performance in regards to price stability.

This goal is assessed in terms of the inflation rate. Inflation can be defined as a sustained increase in the general price level over a period of time. There are several important parts to this definition, so it is worth taking a moment to consider it further.

A sustained increase means that the change in price must be ongoing. Sometimes a business will have a sale, but we would not refer to this as a “sustained decrease in prices” – rather it is a one off event. Similarly, from time to time we may see a one off increase in the price of a good or service. For example, during a drought (as was experienced in Australia during 2006 and 2007) it may be more difficult for certain fruits and vegetables to be produced, and as a result the price of these items may increase. Policy makers recognize that they can not control these sorts of events, and so they do not change economic policies to try and combat them. On the other hand they will do whatever they can to avoid sustained increases that are outside the goal range.

The general price level means that we are looking at a basket of goods and services and assessing the changes in the OVERALL price. Some items may go up in price, while others may in fact go down. Despite this if the overall price has increased then we would say that the economy has experienced inflation. In other words, in assessing the rate of inflation we are not interested in a change in price of any single item, only the overall change in price. (For example, in the data published in October 2006, we can see that the overall price of food increased by 9.9% for the twelve months to September 2006. At the same time, the price of clothing and footwear fell by 1.8%. After reviewing all of the categories, the Australian Bureau of Statistics concluded that the inflation rate was 0.9% for the quarter, or 3.9% over the preceeding year.)

The definition also states that we look at price changes over a period of time. In Australia, the rate of inflation is calculated every quarter (ie three months), but normally we would expect to see an annual rate of inflation quoted. This can be obtained by adding the rate for each of the last four quarters. If we say that the inflation rate is 2.6% over the last 12 months, that suggests that when we examined the previous four quarters the total (sum) of the four was 2.6%. In other words, if our basket of goods and services (or regimen) cost $100 a year ago, today it costs $102.60.

It is also important to note the definition of two other words closely associated with inflation.

Deflation: A sustained decrease in the overall price of a basket of goods and services over a period of time. Australia has not experienced deflation in the last ten years, but the Japanese economy has suffered from this problem in recent times.

Disinflation: Imagine a situation in which the inflation rate was 6.0% in year 1, and 2.9% in year 2. The inflation rate is lower in year 2, however prices have continued to rise (in this case by 2.9%). We refer to this trend as disinflation – when the economy continues to experience inflation but at a lower rate than the previous year.

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