"Outline the significance of inflation in the Aust economy"?

Question

Hi. I have an economics assignment to complete and this final question is holding me back. Can anyone out there help me with this. Any answer or guide to relevant info will be highly regarded. Cheers :)

Answer 1

The Reserve Bank of Australia (www.rba.gov.au) has responsibility for setting interest rates to keep inflation under control in Australia. The reasons are set out in the agreement between the RBA and the Australian Treasurer as being "Both the Bank and the Government agree on the importance of low inflation and low inflation expectations. These assist businesses in making sound investment decisions, underpin the creation of new and secure jobs, protect the savings of Australians and preserve the value of the currency."

The links I have included contain more information taht should help you. The term 'price stability' is just another expression meaning 'low inflation' since if inflation is high, then prices must be increasing and by definition this means that theiy're not stable.

Answer 2

One of our readers has asked me for an Austrian opinion on the 1993 study The Costs of Unemployment in Australia, produced by the Economic Planning and Advisory Council and co-authored by Raja Junankar and Cezary Kapuscinski. It seems that this paper is still being used by some economics lecturers to demonstrate that a “fight inflation first” policy generally incurs more costs than benefits.

I clearly remember this study being favourably reviewed by Michael Stutchbury in The Australian Financial Review. My opinion of the thinking behind the paper not only remains unchanged but has hardened further. The reason for this is that even though 12 years have passed no attempt seems to have been made by economic commentators, both in the media and in our so-called think tanks, to establish a link between inflation and the higher levels of unemployment that have a tendency to emerge at the end of each boom.

The striking thing about the study is that, like those who reviewed it in the media, it showed a startling degree of ignorance of those aspects of monetary and capital theory that render such studies theoretically worthless. The study was fatally flawed by two factors:

1. The authors’ implicit assumption that money is neutral in the sense that increases in the quantity of money only influence the price level and not individual prices, thus changing the structure of relative prices.

2. They adopted the neoclassical approach of treating capital as a homogeneous blob and not a heterogeneous structure.

The authors, as do most economists, especially in Australia, ignored the vitally important fact that any increase in the quantity of money will change the structure of relative prices; meaning that monetary expansion will not change all prices at the same time or to the same extent or degree. The effect of monetary expansion, particularly through credit expansion, is to distort the capital structure, causing malinvestments, i.e., investments that would not ordinarily pay for themselves.

As the much ignored Austrian school continually points out new money is injected into the economy at different points. These monetary injections change the distribution of the money stream between all the stages of production. This monetary process misdirects labour and capital into lines of production whose activities are become dependent on increasing quantities of money. Once government is forced to apply the monetary brakes, as eventually it must, the misdirected labour and capital (the malinvestments) reveal themselves in the form of excess capacity and rising unemployment.

It follows that the critics of “fight inflation first” policy are seriously wrong. The unemployment they are attacking is not the cost of fighting inflation at all — it is the cost of having inflation. The phenomenon of a higher level of unemployment after each monetary crunch can be explained by governments returning to inflationary policies before the malinvestments from the previous inflation have been liquidated.

The problem of persistent widespread unemployment is, however, caused by raising the cost of labour services above their market clearing levels. For this we can thank a callous union movement, its Labor Party allies as well as its media mates. The latter because they continually attack, without any serious attempt at a refutation, those who have the temerity to publicly tell the truth about unemployment and labour costs.

Answer 3

The Dismal Science - my sympathy. Relax. Only your professor believes it makes a difference. The news media runs public perception of the economy, and the only financial advisors who make public comments are trying to direct the stampede in a direction that profits themselves first.