Low Inflation

Policy Options

The major weapon used to fight inflation is monetary policy. As has been highlighted earlier, the RBA believes that an increase in interest rates will lead to a decrease in aggregate demand, and therefore pressure on the rate of inflation in the Australian economy will be reduced. This policy is implemented with the recognition of an 18 month impact lag – the RBA attempts to predict the rate of inflation as it will be 18 months into the future, and interest rates are changed based on these predictions.

The success of the RBA in fighting inflation in the Australian economy is very strong. During the last five years inflation has not been recorded above 4.5% - and this figure can be attributed to factors which were outside the control of the RBA. Despite this, our average rate of inflation for the period has been between 2% and 3%. In other words, the Australian economy has achieved its goals in regards to inflation.

Fiscal policy was not used to tackle inflation in the Australian economy under the previous government, but the Rudd government has approached this in a different way. It has been previously noted that any spending by the government may place some demand side pressures on the economy, and it is true to say that when implementing fiscal policy the government will be wary of placing any pressure on the productive capacity of the economy, because this would add to the rate of inflation.

On the other hand, microeconomic reforms can have a very strong affect on prices in Australia. In your study of Unit 4, you will discover that changes to the airline industry, the telecommunications sector and the financial sector have all resulted in decreased pressure on prices. The long term impact of these changes is that productive capacity in the Australian economy is improved, and therefore we are more able to cope with increases in aggregate demand.

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