| Supply Factor |
Theoretical Link to Inflation |
Evidence |
| Interest Rates |
When interest rates increase producers will need to use more of their revenues and profits to repay existing loans. As such any increase in the cash rate will lead to higher costs of production, and this in turn may mean a decrease in aggregate supply.
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Interest rates have a stronger impact on aggregate demand than they do on aggregate supply, and as such they are used as the major weapon to fight demand side inflation. Despite this, it is possible that the increase in interest rates during 1999/2000 (up to 6%) contributed to the inflation rate of 6% recorded in the following year. Similarly, increasing rates during 2006 may have contributed to the increase in inflation during that year - inflation peaked at 4.0% in May of that year.
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| Wages |
Wages are another very significant cost of production. When wages increase businesses are faced with the prospect of paying more to produce the same level of output. Once again, with the increase in production costs it is possible that aggregate supply will decrease.
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Due to productivity gains, real unit labour costs (RULCs) have not fluctuated widely during the last 10 years. However, consistent increases can be seen during the years between 2002/03 and 2005/06. As a result, the rate of inflation increased steadily during this period.
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| The Exchange Rate |
As the value of the Australian dollar decreases, aggregate supply may fall. Around 80% of all imports are used in the production process, and so when the dollar is weak it costs more to purchase these productive imports. This equates to higher costs of production, and hence aggregate supply may decrease.
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The TWI reached a low point for the period in 2000/01 (49.7). It is not coincidental that this coincided with increasing rates of inflation – reaching 6.0% in 2000/01. A higher dollar almost certainly contributed to the delay in increasing interest rates in 2005/06. During this period, the appreciation of the AUD helped to keep inflation lower than would otherwise have been the case.
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| Productivity Gains |
When businesses are more productive the pressure on aggregate supply is reduced, and the impact on inflation may be positive. However, if productivity gains are not able to be sustained, this may lead to an decrease in aggregate supply, and subsequently cost inflationary pressures in the economy.
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In 2004/05 labour productivity in Australia was very poor. In fact, labour actually became less productive during this period, falling by 0.4%. As a result, inflation increased to 3.0% in this year, and ultimately moved outside the acceptable band in the year after.
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| Company Tax Rates |
Again, the company tax rate represents a significant cost of production. If the tax rate decreases then it is likely that these benefits will be passed on to consumers in some way – businesses are more likely to start, aggregate supply will increase and therefore shift to the right.
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Between 1999/2000 and 2001/02 the company tax rate was lowered in two stages, from 36% to 30%. After peaking at 6.0%, the rate of inflation quickly returned to the goal range, falling to 2.8% in the following year.
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Unit 1
Unit 3
