INFLATION AND PROGRESS

Inflation - an upward movement in the general level of prices - can impose costs on individuals and the economy. Over time, inflation reduces the purchasing power of money and can lead to market inefficiencies. A low and stable rate of inflation is desirable both for the health of the economy and for individual welfare.

Inflation is an important aspect of progress as it affects economic stability. Large or unanticipated changes in prices can distort the behaviour of consumers and businesses, who may find it more difficult to predict the effects of their saving and investment decisions. Inflation can also put upward pressure on wages as people struggle to meet rising costs, and can reduce trade competitiveness as prices of exports increase.

Although inflation is defined as a rise in the general level of prices, not all prices change at the same rate or even in the same direction. For this reason, inflation can also affect the distribution of real income and wealth among individuals and households. For example, a relatively steep increase in the prices of items that make up a large part of low income households’ expenditure can cause greater inequality in the distribution of real household income (University of Melbourne 1996).

Inflation, while not included as a headline dimension, has been included as a supplementary dimension because of its relevance to progress. There is no single correct measure of inflation. Ideally, an indicator would be comprehensive, covering price changes for all goods and services traded in the economy. But different measures of price change are suited to analysing different economic phenomena, and so instead, this commentary relies on two commonly used indicators of inflation - the Consumer Price Index (CPI) and the national accounts chain price index for Domestic Final Demand (DFD). While both are influenced by temporary market volatility, and neither are immune to other economic influences, they are the most comprehensive indicators available to provide a broad picture of inflationary trends in the medium to long term.

Further information has also been provided on the capital and consumption components of inflation. Statistics on these components are also important as they describe how prices for capital assets, and for goods and services, have changed in Australia over time.

For a full list of definitions used in Inflation, please see the Inflation glossary.