Australia: Inflation and Monetary Policy Essay

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When there is high inflation, it indicates that prices of goods are rising, which in turn indicates that people have additional money to spend and hence money supply is far beyond the levels expected by the central bank. In such a case, central bank can use monetary measures to control inflation. These are usually in terms of interest rate increases which can curtail lending and borrowing and drains excessive money out of the economy. This can help in bringing down the prices and hence the rate of inflation.

However when inflation is low, the opposite of these measures is adopted to allow more lending by the banks and people can borrow more easily hence accelerating economic activity in the country.

If Australia's inflation rate rises, it is not a cause of concern if it is still close to the target but can turn into a serious issue if inflation is much beyond the target. This is because Australia depends on low inflation for its prosperity. In the last few years, the robust growth in economy has been due to low interest rates. In a high inflation scenario, these rates can no longer be offered to the public which can cause problems as economic activity would slow down. This is what had happened in 1970s and 1980s when inflation was much higher than what RBA had expected. These two decades of high inflation forced RBA to actively target inflation rate to keep it around 2-3%. Australia's consistent drive to bring down the inflation rate is grounded in the fear that high inflation would result in economic slow down.

Meredith and Dyster add: "High inflation rates persisted in Australia from the early 1970s to the beginning of the 1990s.

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During that period, economic growth was on average below the levels of the previous two decades and there were recurrent bouts of economic stagnation. The full employment conditions of the post war period were gradually eroded, with double digit unemployment rates being reached at the beginning of the 1980s and the 1990s. Australia's external balance deteriorated, causing a balance of payment crisis by the early 1980s." (p 249)

The best monetary measure which worked for Australia was contracting the market by raising interest rates thus controlling the money supply. Thus RBA decided to keep a close watch on inflation rate with the help of interest rates too and it paid off when in 1990s, economy saw acceleration and inflation rate came down. Since 1996, the rate has been down and Australia would want to keep it this way in order to continue the trend of prosperity.

In the case of inflation, Australia will not have immediate problems but can face serious economic challenges like it did in 1970s and 1980s. With high inflation, RBA will need to contract the economy by using the tool of fund rate hikes. Expansionary measures are needed only when economy is contracting and there is low inflation rate. This kind of measure is being used in Australian economy today as RBA continues the trend of reducing interest rates thus allowing economy to prosper......

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