Australia’s Record Breaking Deflation


What Has Happened?

On the 29th of July 2020, it was released that the inflation rate for the June 2020 quarter was -0.3% which confirmed that the Australian economy was experiencing a fall in the general level of prices and thus a state of deflation. It has been 22 years since the last deflation occurrence, and further, the drop in the Consumer Price Index (CPI), which is the index used to measure changes in prices, that actually yielded the -0.3% rate was the largest drop in CPI ever recorded by the Australian Bureau of Statistics (ABS). This is yet another concern to arise amidst the COVID-19 recession.

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It can be deduced that the deflation at hand is linked to the quarterly declines in economic growth characteristic of the COVID-19 recession. Such declining of economic growth, with its lower levels of production and thus lower use of factors of production including labour, tends to increase the level of unemployment. An increase in unemployment, which indeed is currently occurring as per current figures, decreases both the willingness and capacity of individuals to consume. This decreases the value of the consumption component of the aggregate demand function (Y = C + I + G + X - M), which then decreases aggregate demand (if all other things remain equal) and subsequently places downward pressure on prices. This process reflects the concept of demand-pull inflation/deflation in which changes in aggregate demand influence the level of inflation.

However, a decrease in the consumption component that is more niche to the COVID-19 aspect of the recession is the fall in the demand for, consumption of and thus prices of petrol which can be attributed to lockdown preventing individuals from leaving their homes unless absolutely necessary and hence decreasing the need for methods of commuting from place to place such as driving.

However, more than just cyclical factors associated with the nature of the recession influenced the aggregate demand components and thus constituted demand pull deflation; specific government policies involving childcare and education were at play according to the ABS.

In the Morrison Government choosing to make childcare temporarily free in light of the strain placed by COVID-19 on households, consumption on childcare and thus the consumption component of the aggregate demand equation decreased, also placing a downward pressure on prices. The consumption component was further decreased by the fact that in New South Wales, Victoria and Queensland, spending on education services fell as pre-school was made free, again due to the strain placed by COVID-19 on households.

Supply side reforms focused on structural change, a policy type Frydenberg has referred to as ‘Thatcher-Reagan economics’, have been at the forefront of policy discussion both politically and in the media due to the notion that such reforms have the ability to stimulate economic growth and in turn, apply upward pressure on inflation. This is supported by the argument that supply-side reforms have the ability to positively influence what are called the ‘three P’s’ of economic growth; population, participation and productivity.

However, criticisms have emerged from the fact that the process of structural change facilitated by microeconomic reform, especially when targeted at productivity in particular, has many short-term costs including slow growth, high unemployment and in turn, low inflation, due to the mass shifting of resources between different areas in the economy. Although these short-term costs can at least partially be offset by components of fiscal policy targeted toward maintaining and stimulating an acceptable level of the economic issues mentioned earlier, the capacity for the government to juggle both policy considerations may be limited as per the already rising budget surplus.

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