the nature and extent of inflation inflation is a sustained rise in the general level of prices in an economy. Several measurements of inflation are available but the most widely used measurement in australia is the consumer price index cpi , which measures the percentage change in the prices of selected consumer goods and services over time and therefore reflects changes in the cost of living. The rate of change in the cpi is known as the headline rate of inflation since it covers the movement in the prices of a basket of goods and services weighted according to their significance in the average australian household.

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Some problems in the interpretation of the cpi include the volatility of some prices due to seasonal conditions such as food prices , and the change in the weightings given to various categories of spending over time due to changes in consumer spending behaviour. The cpi for the march quarter 2003 showed a rise in the general level of prices of 1.3%, bringing the annual rate of inflation to 3.4%. Additional measures of inflation are also used to assess the degree of price pressures in the economy. One such measure is the underlying rate of inflation, which is a calculation of inflation that removes one off seasonal factors such as higher food prices due to drought or government induced interest rate rises.

It is a better indicator of trend inflation in the economy than headline inflation and is calculated by treasury and used in economic forecasting. The australian bureau of statistics has also recently developed new measurements of inflation. The price index of domestic final purchases analyses price changes on the demand side of the economy, which the stage of production index analyses price changes on the supply side. When the level of aggregate demand exceeds the productive capacity of the economy, demand pull inflation occurs, as output cannot expand any further.

Consumers force prices up by bidding against each other for the limited goods and services available. Demand pull inflation can be caused by increases in consumption, investment, money supply, government expenditure and export income. Cost push inflation results from a decrease in aggregate supply caused by an increase in the costs of production.

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When there is an increase in costs of production, such as an increase in the price of raw materials, business attempt to pass them on to the consumer by raising the prices of their products. One of the main causes of cost push inflation is an increase in wages, as wages costs account for up to 70% of total business costs. When wages increase faster than productivity, the cost of labour for each unit of output increases.

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Businesses will attempt to pass the wage increase on to consumers in order to maintain profitability. This type of inflation is transferred to australia through international transactions. If there is an increase in the price of imported goods, importers will attempt to pass on the effect of higher costs onto consumers in the form of higher prices, leading to imported inflation. A depreciation in the $a will also increase the domestic price of imports and will lead to inflation. If the key participants in the economy expect an increase in the rate of inflation, they will attempt to protect themselves from it. For example, if employers expected further increases in their costs of production, they may raise prices in order to cover the expected increase in costs, resulting in inflation.

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Similarly, if trade unions argue for wage increases based on anticipated inflation rather than on the current inflation rate, it will lead to cost push inflation. Consumers lose purchasing power due to a decrease in real incomes, leading to a decrease in living standards. Workers suffer a fall in real wages and those on low wages or fixed incomes also experience a fall. There is therefore a redistribution of income away from wage and salary earners to those receiving profit and dividend income. Producers may react to higher costs by putting up prices and may shed workers to contain their costs, leading to stagflation.

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Exporters may find it difficult to compete with higher production costs, leading to a temporary loss in competitiveness. Savers will find that the real value of savings well decline unless interest rates are raised. Some investment may increase, but it will be in speculation, eg property, rather than investment in productive capacity. Inflation will force up nominal wages for workers, pushing them into higher tax brackets and therefore generating greater government revenue fiscal drag. government responses to inflation an important source of actual inflation is expectations of inflation.