Inflation is a persistent and appreciable rise in the general level of prices over time
On the converse, we have deflation
Measurement
The most familiar measure of the level of inflation in Australia is the Consumer Price Index
It measures changes in the price of a basket of goods and services bought by Australian consumers in a time period
Items are classified into eleven major groups, 33 subgroups, and 87 classes of expenditure
Different groups and items have different priorities - a rise in fuel prices would have more impact than a rise in cocaine prices (cocaine is illegal, so it has less demand)
Thus, the ABS attaches weights to products - these weights may change each year based on a review each December
Headline vs Underlying inflation
Headline Measure is the measure reported by the media
Trimmed Mean: removes the most volatile 15% of items from each side of the CPI
Weighted median: changes the median by weight
CPI excluding volatile items: Average inflation rate of all items in the CPI basket except for fruits, vegetables or fuels (these are very volatile items) - this is all constant, unlike trimmed and weighted median.
Limitations
Does not account for quality of goods and services - only price
Does not reflect changing consumer preferences or substitutes that consumers make daily
it is more likely to overstate price increases.
Only reports price movements in metro areas (specifically, capital cities)
Types
Demand-Pull
'too much money chasing too few goods' - i.e., households and businesses are spending more than they normally would, causing prices to rise due to competition
Indicators are
High levels of consumer confidence
Low levels of spare capacity in key industries
Rising wages that increase disposable income
High levels of credit use
Rises in property or share market asset prices
For demand-pull, different sectors of the economy will be affected differently
Will also push wage prices up with higher demand
Cost-Push
Rising output costs are passed onto consumers, who then pay higher prices
Episodes of cost-push can be attributed to
Rising oil/petrol prices
Rising import prices <-- currency depreciation
wages rising faster than productivity
natural disasters such as flood and drought
Both are very generalised
Effects of inflation
Moderate inflation == good for economy
it encourages borrowing and consumption
Can be a burden if the cash rate (directly influenced by $CPI$) creeps above $4-5%$.
Inflation reduces real income or purchasing power
It affects interest rates, as the real interest rate (nominal interest rate - inflation) must be positive
this means higher rates are good for savers, but bad for borrowers
It can affect international competitiveness, as exports are at a disadvantage (relatively) when domestic inflation is high
Can result in currency depreciation
because there is less overseas demand for a country's good
Capital-for-labour substitutions
Also, uncertainty and economic efficiency are impacted