Unit 1
Unit 3
Low Inflation
International Comparisons
Every country fights its own battle with inflation. As an economy grows it is inevitable that prices will rise; the health of the economy can be assessed by the rate at which that change occurs.
Australia is a low inflation country. Since the early 1990s our rate of inflation has varied between 0% and 6% (which was largely due to the one off impact of the introduction of the GST), but it has averaged a healthy 2.5%. This makes our country an attractive destination for overseas investment, and a logical country from which to source imported goods and services. Most developed, western economies have been able to achieve this goal. For example, inflation targeting has generally been successful in New Zealand, the United States of America, Canada, Ireland and most of mainland Europe.
However, not all countries are able to be classified as having low inflation economies. For example, some countries in South America have struggled to contain the inflation that has been recorded. After World War II, inflation in Argentina averaged 26% per year for thirty years. At this rate prices would double approximately every three years. By 1980 an attempt to bring the economy into the modern world saw inflation increase to 100% - this suggests that prices would double in one year. To try and overcome this problem, the government of Argentina kept updating their currency; this happened four times between 1970 and 1991. In 1991 a more radical approach to modernising the economy was adopted, and inflation fell below 10% per year during the 1990s. It seems that the problems did not end there though; by 2008 inflation was being recorded at 20% per annum, and it was apparent that the government was manipulating the published statistics. The actual rate could have been even higher.
These events suggest that Argentina is a high inflation economy. There are some countries in the world where the problem is even worse. For example, in Zimbabwe the rate of inflation has recently been so high that it is impossible to calculate. Prices increased so quickly (and so much) that no assessment was possible. Rough estimates suggest that the rate of inflation may have reached the improbable figure of one million percent. At this rate prices were doubling more than once per day. At this rate it is fair to say that the economy of Zimbabwe was suffering from hyperinflation. The government originally tried printing new money, but this only fuelled the problem. During 2009 a new strategy was adopted; although it was only loosely sanctioned by the government, people began to use the US dollar as the main currency. While this is not an ideal situation, it did allow the policy makers in the Zimbabwean government to focus on economic problems other than inflation for some time.
Countries like this will struggle to find ways to allow their citizens to increase their living standards. However, there is one other type of economic problem associated with this that can also cause problems for a country.
Between 1999 and 2009, the economy of Japan generally experienced deflation. That is, prices actually fell from one year to the next. At first this might sound like a very good thing, but it is actually a terrible event to see in a developed economy. Imagine for a moment that prices were falling here in Australia, and you were planning to purchase a new car. What would you do? The odds are that you would wait and see how far prices could fall – you would delay your spending. What if you were thinking about opening a business? In an economic climate where prices are falling, you might find that any stock you buy today will need to be sold below cost price at some point in the future. It is therefore likely that you will wait until the fall in prices has stopped.
In other words, the economy starts to go backwards. People stop spending, new businesses don’t open, and this actually acts to make the problem of deflation even worse. It is for this reason that the Japanese economy has been a major concern to economists all over the world for some time now. For some of this period interest rates were effectively 0%; it was possible to borrow money for free. Despite this, the economy did not start to grow, and the global financial crisis of 2007-2009 made matters worse.
Based on all of this, it is reasonable to assume that the Australian government will work to maintain our place as a low inflation country.
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