Policy Impact

Low Inflation

The impact of the microeconomic reform process on the rate of inflation in Australia has been dramatic. We have already seen that in implementing microeconomic reforms the Australian government is aiming to move the supply curve in that particular industry to the right. This should result in the equilibrium point being lower on the graph than it previously was.

In general, we would say that this should mean that there is no upward pressure on prices. The Australian economy has only very rarely experienced deflation, and so it is unusual that a fall in prices should result. However, the combination of increasing efficiency and stronger competition has meant that lower prices have been observed in some industries. It can take some time for an aggregate supply policy to have its full impact, and so the majority of useful examples tend to be more than ten years old now. However, the recent deregulation of the dairy industry can help to illustrate the point.

The dairy industry used to be strongly supported by payments from the government. Until 1999, subsidies of up to 40% were common. In September 1999 the Dairy Structural Adjustment Support Program was announced. In general terms this program offered payments to farmers who no longer wanted to produce dairy products, while others were told that the financial support they were receiving would be removed. Many farmers did choose to accept payouts, but this created much larger markets for those who remained. The end result was a smaller number of dairy farms, but a significant increase in output. In other words, the industry became a lot more efficient. It is for this reason that the price of a litre of milk has fallen in real terms since 2005.

The dairy industry in Australia

On the other hand, it is worth remembering that any attempt to introduce an emissions trading scheme is likely to result in a one-off increase in the rate of inflation. This is part of the reason that the government has struggled to pass this legislation through the Senate. Some estimates suggest that the carbon pollution reduction scheme (as it is currently designed) will result in inflation increasing by 0.9%.

Older examples of industries that have experienced downward pressure on prices are:

Aviation – On some routes, prices have fallen by as much as 30% since 1998. We have also seen an increase in the number of flights available. Special deals (such as internet sales of last minute seats) can mean that actual prices paid are a small fraction of what they once were.
Public Utilities -Electricity and gas prices have fallen by up to 25% for businesses. However, the impact on consumers has not been as strong. Between 1995 and 2005, prices did fall, but only by 1-2%.
Freight – The cost of moving goods around Australia has fallen significantly. Rail freight costs are down by 40%, and air freight costs are 30% lower than they were in 2000.
Telecommunications – In real terms, the cost of a local telephone call has fallen by 25%. However, this has been offset to some extent by the increasing use of mobile telephones. A call to or from a mobile can cost significantly more than a local call made between landlines.

There are also flow-on benefits of these changes for the rest of the Australian economy. As prices have fallen in infrastructure industries, other businesses have benefited from lower production costs. This has resulted in a shift in the aggregate supply curve – the equilibrium point has moved down and to the right. In this instance, it is likely that the increase in supply has been matched by a corresponding increase in demand, and so the general price level will not fall. However, the real benefit for the Australian economy lies in the fact that the overall rate of inflation will be lower. Low inflation will assist in making growth sustainable, and also in helping the Australian economy to achieve external stability.

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