Causes of Inflation in Australia
Expert reviewed • 14 August 2024 • 10 minute read
Understanding the causes of inflation helps policymakers design effective measures to control it. The primary causes of inflation in Australia are demand inflation, cost inflation, imported inflation, and inflationary expectations.
What is Demand Inflation?
Demand inflation, also known as demand-pull inflation, occurs when aggregate demand in the economy exceeds aggregate supply at the current price level. This excess demand pulls prices upward. This type of inflation is typically driven by strong consumer spending, increased business investments, government expenditure, and net exports.
Causes of Demand Inflation
The main causes of demand-pull inflation are as follows:
- Consumer Spending: When households experience higher disposable income, they tend to spend more on goods and services. This increase in demand can drive up prices.
- Business Investments: Increased investments by businesses in infrastructure, technology, and expansion can boost demand for raw materials and labour, leading to higher prices.
- Government Spending: Expansionary fiscal policies, such as increased government spending on public projects, can elevate overall demand.
- Net Exports: A surge in demand for a country's exports can increase the aggregate demand, leading to higher prices.
Example of Demand-Pull Inflation: Post-COVID Economic Recovery
In 2021, Australia experienced a sharp economic rebound following the initial impact of the COVID-19 pandemic. This recovery was characterised by:
- GDP growth of 4.9% in 2021
- Record-low interest rates (cash rate at 0.1% until May 2022)
- Significant fiscal stimulus (e.g., JobKeeper programme)
These factors contributed to a surge in demand, putting upward pressure on prices. This surge in demand is demonstrated by the shift in a supply vs demand graph. Learn more about this type of graph in Supply vs Demand Graph module.
What is Cost Inflation?
Cost inflation, or cost-push inflation, occurs when the costs of production increase, leading businesses to raise prices to maintain profit margins. This type of inflation is often driven by higher wages, increased raw material costs, and supply chain disruptions.
Causes of Cost Inflation
The main causes of cost-push inflation are as follows:
- Wages: When wages increase, production costs rise as businesses spend more on labour. This can lead to higher prices for goods and services.
- Raw Materials: An increase in the cost of raw materials, such as oil, metals, and agricultural products, can raise production costs.
- Supply Chain Disruptions: Events like natural disasters, geopolitical tensions, and pandemics can disrupt supply chains, leading to higher costs for businesses.
Example of Cost-Push Inflation: Energy Price Increases
In 2022, Australia experienced significant increases in energy prices due to global factors and domestic issues. These increases included wholesale electricity prices rising by 141% in the year to March 2022 and gas price increases of 50-100% in some regions. These energy price increases contributed to cost-push inflation across various sectors of the economy.
What is Imported Inflation?
Imported inflation occurs when the prices of imported goods and services rise, leading to higher domestic prices. This can be caused by fluctuations in exchange rates, global commodity prices, and economic conditions in trading partner countries.
Causes of Imported Inflation
The main causes of imported inflation are as follows:
- Exchange Rates: A depreciation of the domestic currency makes imports more expensive, contributing to higher inflation.
- Global Commodity Prices: Increases in global prices of commodities such as oil, gas, and food can lead to higher import costs.
- Economic Conditions Abroad: Inflation in major trading partners can be transmitted to the domestic economy through higher prices for imported goods.
Example of Imported Inflation: Impact of Global Supply Chain Disruptions
The COVID-19 pandemic led to significant global supply chain issues, affecting the prices of imported goods in Australia:
- Shipping costs increased by over 300% between 2020 and 2021
- Semiconductor shortages led to price increases in electronics and automobiles
These factors contributed to inflationary pressures on imported goods.
What are Inflationary Expectations?
Inflationary expectations refer to the anticipation of future inflation by businesses, consumers, and investors. If people expect higher inflation in the future, they may act in ways that contribute to actual inflation, causing these expectations to become "self-fulfilling."
Causes of Inflationary Expectations
The main causes of inflationary expectations are as follows:
- Past Inflation: Historical inflation trends can influence expectations. If inflation has been high in the past, people may expect it to continue.
- Monetary Policy: Central bank policies and statements can shape expectations. If the central bank signals that it expects higher inflation, businesses and consumers may adjust their behaviour accordingly.
- Economic Indicators: Data on economic growth, unemployment, and other indicators can influence expectations. Strong economic performance may lead to expectations of higher inflation.