Inflation & unemployment

What is inflation

A persistent and appreciable (significant) rise in the general level of prices in an economy.

What is dis-inflation

When prices are still rising, but at a slower rate than before (a positive but decreasing rate of inflation).

What is deflation

A sustained fall in the general level of prices.

What is Australia's inflation target

2 to 3 per cent, on average, over time.

When did the RBA adopt its inflation target

In the early 1990s.

Why doesn't the RBA target 0% inflation

Because 0% inflation risks tipping into deflation, which is linked to economic downturns and recessions; a low but positive target (2-3%) better supports sustainable growth and employment, and lets the RBA lower real interest rates to stimulate the economy during downturns.

What is the formula for the real interest rate

Real interest rate = Nominal interest rate − Inflation rate.

What is an index number

A tool economists use to compare prices at different points in time; a base year is set and assigned an index value of 100, and later years are compared to this base.

Give examples of indicators that use index numbers. The Consumer Price Index (CPI), the Trade Weighted Index, and the Commodity Price Index.

How often does the ABS survey prices to calculate the CPI

Quarterly.

How many goods/services and categories does the ABS track for the CPI

Around 100,000 goods and services, grouped into 87 categories (expenditure classes) and 11 groups.

From what sources does the ABS collect CPI price data

Retailers, supermarkets, department stores, websites, government authorities, energy providers, real estate agents, and scanner data from supermarkets.

How does the ABS decide the weighting of items in the CPI basket

Based on how much of household income is spent on each good/service — items taking a larger share of spending get a larger weight in the CPI.

How often is the CPI basket (regimen) reviewed by the ABS

Every five years, to ensure it accurately reflects average household buying patterns.

What is the formula for the Consumer Price Index (CPI)

[ CPI = \dfrac{\text{Current value of the basket of goods}}{\text{Base year value of the same basket of goods}} \times 100 ]

What are the preset steps to calculate the CPI for a given year

1. Multiply the price of each item by its weighting (Price × Weighting) for every year, then sum to get total expenditure.
   2. Assign the base year (Year 1) an index value of 100.
   3. For each subsequent year, calculate total expenditure the same way.
   4. Divide that year's total expenditure by the base year's total expenditure, then multiply by 100.

Why must CPI always be calculated by dividing by the base year expenditure, not the previous year

Because the index must show cumulative price change relative to a fixed base level (=100), not just change from the immediately preceding year — using the previous year each time would compound and no longer reflect a consistent index.

What is the formula for the inflation rate

[ \text{Inflation rate} = \dfrac{CPI(\text{current period}) - CPI(\text{previous period})}{CPI(\text{previous period})} \times 100 ]

What are the preset steps to calculate the inflation rate between two periods

1. Take the CPI of the current period and subtract the CPI of the previous period.
   2. Divide this difference by the CPI of the previous period.
   3. Multiply the result by 100 to express it as a percentage.

Why must the inflation rate always be calculated relative to the period immediately before, not the base year

Because it measures the percentage change in prices from one period to the next, not cumulative change since the base year (that's what CPI itself measures).

What is headline inflation

The overall/official rate of inflation as measured by the CPI, covering the full basket of goods and services including volatile items.

What is underlying inflation

A measure of inflation that excludes items with particularly large (often temporary) price changes, revealing the more persistent, stable trend in prices.

What are the two main measures of underlying inflation used in Australia

The trimmed mean and the weighted median.

What items are typically excluded when calculating underlying inflation

Fuel and energy prices, fresh fruit and vegetables, holiday travel and accommodation, and insurance premiums.

Why does the RBA pay close attention to underlying inflation rather than just headline inflation

Because underlying measures strip out temporary/volatile price shocks, allowing the RBA to focus on persistent inflation trends when making interest rate decisions.

When large temporary price increases occur, how does underlying inflation compare to headline inflation

Underlying inflation is lower than headline inflation, because the large price increases are excluded from the underlying measure's basket.

When large temporary price decreases occur, how does underlying inflation compare to headline inflation

Underlying inflation is higher than headline inflation, because the large price falls are excluded and don't pull the underlying rate down.

Why is it wrong to interpret the CPI as measuring the "price level" (e.g. that eggs are more expensive than bread if egg's index is higher)

Because the CPI measures the rate of price change of an item relative to its own base value, not the absolute dollar price — a higher index number for eggs just means eggs' price has risen more since the base period, not that eggs cost more.

What is the "coverage" limitation of the CPI

It only measures price changes in the metropolitan areas of Australia's eight capital cities (about two-thirds of households) — it doesn't capture regional, rural, or remote price changes, or differences between individual household spending patterns.

What is the "quality change" limitation of the CPI

The CPI intends to measure pure price changes only, ignoring quality improvements/declines in goods (e.g. an upgraded phone camera), which is difficult to adjust for accurately.

What is "substitution bias" in the CPI

Because the CPI doesn't frequently adjust for changing household spending patterns, when households substitute away from goods that rise in price (e.g. buying more beef when lamb prices rise), the CPI over-weights the more expensive good, biasing the index upward.

What is the "new products" limitation of the CPI

New products are not included in the CPI basket as soon as they appear on the market; inclusion is delayed until they reach a high enough market share.

What is demand-pull inflation

Inflation caused when aggregate demand (AD) in the economy exceeds aggregate supply (AS) — "too much money chasing too few goods" — putting broad upward pressure on prices.

Using the AD/AS model, describe the sequence of events for demand-pull inflation. 1. Economy starts in equilibrium at output Y, price level PL.
2. AD increases (e.g. due to a rise in C, I, G, or Net X).
3. The rise in AD pushes the price level up from PL to PL1.
4. The higher price level causes AS to expand from Y to Y1.
5. New equilibrium at a higher output (Y1) and higher price level (PL1).

List the main causes of demand-pull inflation. Rising consumption spending (especially discretionary), lower interest rates (boosting spending/investment and asset prices), depreciation of the AUD (raising net exports), rising government spending (deficit budgets or tax cuts), and rising inflation expectations ("inflation psychology").

How does a fall in interest rates cause demand-pull inflation via two channels

1. Directly: lower rates boost consumer and investment spending.
   2. Indirectly: lower rates raise demand for houses, raising house prices, creating a positive wealth effect that boosts consumer spending.

How does a depreciation of the AUD cause demand-pull inflation

It makes exports cheaper for foreign buyers (raising export demand) and imports more expensive in AUD terms (lowering import demand); the resulting rise in net exports raises AD.

How do rising inflation expectations cause demand-pull inflation

If people expect prices to rise, they bring forward consumption to avoid paying more later, raising current AD ("inflation psychology").

What is cost-push inflation

Inflation resulting from an increase in production costs (e.g. wages, raw materials, oil prices), which reduces aggregate supply and pushes prices up.

Using the AD/AS model, describe the sequence of events for cost-push inflation. 1. Economy starts in equilibrium at output Y, price level PL.
2. Production costs rise (e.g. oil, wages), shifting AS left to AS1.
3. The decrease in AS raises the price level from PL to PL1.
4. New equilibrium at a lower output level and higher price level (PL1).

List the main causes of cost-push inflation. Supply shocks (natural disasters, global supply chain disruptions), rising oil prices (raising transport costs for all firms), higher wages (from tight labour markets), and imported inflation (from AUD depreciation raising the cost of imported inputs/goods).

How do natural disasters cause cost-push inflation

They cause shortages of agricultural products and damage infrastructure, leading to shortages of goods and services, increasing their price.

How did COVID-19 illustrate global supply chain disruption as a cause of cost-push inflation

Intermediate/capital goods imported from overseas faced parts shortages, and shipping costs rose, both pushing up production costs.

How does a tight labour market cause cost-push inflation

When labour demand exceeds supply, wage rates rise; since wages are a large share of firms' costs, this raises production costs, causing cost-push inflation.

What is "imported inflation" and how does AUD depreciation cause it

A weaker AUD raises the price (in AUD terms) of imported intermediate/capital goods and imported consumer goods, raising both production costs and the CPI directly.

What is "erosion of purchasing power" as an effect of high inflation

When inflation rises faster than income/wage growth, a given amount of nominal income buys fewer goods and services, reducing the real value (purchasing power) of income.

What is the "wage price spiral"

A self-reinforcing cycle: high inflation → workers negotiate higher wages to maintain purchasing power → higher wages raise consumption (demand-pull) and firms pass wage costs onto consumers (cost-push) → inflation rises further → workers seek even higher wages, repeating the cycle.

How does high inflation distort spending and investment decisions

Investors move money into "safe haven" assets (gold, cryptocurrency) to hedge against inflation, diverting funds from productive investment into speculative markets.

How does inflation affect the real return on investment

If inflation exceeds an investment's nominal return, the real return can turn negative (e.g. a 2% nominal return with 4% inflation gives a real return of −2%).

How does inflation create uncertainty for businesses

It makes business planning difficult, leading firms to postpone investment plans, reducing future output, productive capacity, and job creation.

How can high inflation reduce a country's international competitiveness

A relatively high domestic inflation rate makes exports more expensive versus global competitors, reducing export demand and harming export industries.

How does high inflation cause inequality in income distribution

Well-educated/self-employed people can raise fees/wages and invest savings in appreciating assets to keep pace with inflation; workers with less market power (e.g. nurses, teachers) see income growth lag inflation, reducing their real income.

Why does high inflation discourage saving

Money loses value over time under inflation, motivating people to spend now rather than save, which further boosts AD and demand-pull inflation.

How does high inflation put upward pressure on nominal interest rates

Banks need to maintain a positive real interest rate (Nominal − Inflation) to cover costs and profit, so high inflation pushes nominal rates up — good for savers, bad for borrowers.

Who are the "winners" of high inflation

Debtors, holders of appreciating assets (e.g. houses), people with flexible incomes, people with labour market power, importers, and the government (via bracket creep).

Who are the "losers" of high inflation

Creditors, holders of depreciating assets (e.g. cash), people on fixed incomes, people without labour market power, exporters, and taxpayers (via bracket creep).

What is "bracket creep"

When inflation pushes nominal incomes into higher tax brackets even though real income hasn't necessarily risen, increasing government tax revenue at taxpayers' expense.

What is "delayed consumption" as an issue with low inflation (<2%)

Consumers delay purchases expecting prices to fall further, decreasing Aggregate Demand and worsening deflationary pressure.

How can low inflation contribute to rising unemployment

It's harder for businesses to reduce real wages by keeping nominal wage growth below inflation, so they resort to layoffs instead, further reducing demand and prices.

What was Australia's peak annual inflation rate and when did it occur (per the RBA notes)

7.8%, in December 2022.

What accounted for at least half of the rise in Australia's inflation in late 2022 (RBA, Feb 2023)

Supply shocks — including supply issues from the war in Ukraine, global COVID-19 supply disruptions, and domestic supply disruptions from poor weather.

Besides supply shocks, what other factor contributed to Australia's high inflation

Strong domestic demand from the rapid pandemic recovery, where demand for goods/services exceeded supply capacity.

As at June 2026, what was Australia's annual CPI inflation rate and how did it compare to the previous month

3.8%, down from 4.0% in the 12 months to May 2026.

As at June 2026, what were the largest contributors to annual inflation

Housing (+6.8%), Food and non-alcoholic beverages (+3.3%), and Recreation and culture (+3.3%).

As at June 2026, what was the trimmed mean (underlying) inflation rate

3.6%, unchanged from May 2026.

Which factor would reduce inflationary pressures facing a nation: a rise in crude oil prices, a rise in company tax, an increase in GST, or a global recession

A global recession — it reduces aggregate demand, easing demand-pull inflationary pressure.

Demand-pull inflation is most likely to occur under which business cycle condition

During the expansion phase of the business cycle, when AD is rising toward or exceeding productive capacity.

Cost-push inflation is most likely to occur at what stage of the business cycle

At any stage of the business cycle, since cost shocks can occur independently of demand.

What is the labour market defined as, per ABS data collection

The system in which labour services are bought and sold, measured monthly by the ABS via the Labour Force Survey.

What is the ABS Labour Force Survey, and how often is it conducted

A monthly survey of around 50,000 people (1 in every 312 people aged 15+) about their participation in the labour market.

What is the working age population in Australia defined as

Everyone aged 15 to 64, regardless of employment or study status.

As of 2025, what is Australia's estimated working age population

Around 20 million people.

What is the labour force

All people aged 15 and over who are either employed or unemployed (i.e. employed + actively seeking work).

As of July 2026, what is Australia's estimated labour force size

Approximately 15.7 million people.

Who is classified as "not in the labour force"

People neither employed nor unemployed — e.g. those doing home duties, retired, permanently unable to work, in institutions, in contemplative religious orders, or doing only jury/unpaid voluntary work.

What is a "discouraged worker"

Someone who wants a job and is available for work but has stopped actively searching because they believe they cannot find one; classified as not in the labour force.

Who is classified as "employed"

People who worked for one hour or more in the reference week, including unpaid work in a family business/farm.

What is the distinction between full-time and part-time employment

Full-time = 35 or more hours per week; part-time = more than one and less than 35 hours per week.

As at March 2026, how many people are estimated to be employed in Australia

Approximately 15.1 million people.

Who is classified as "unemployed"

People not in a paid job who are available for work and have actively looked for work in the last four weeks.

What is the participation rate

The proportion of the working-age population who are in the labour force.

What is the formula for the participation rate

[ \text{Participation rate} = \dfrac{\text{Labour Force}}{\text{Working Age Population}} \times 100 ]

How does participation typically move with the business cycle

It rises when businesses are hiring more and offering higher wages (greater incentive to seek work), and falls when businesses aren't hiring and wage growth is low.

List structural influences on the participation rate independent of the business cycle. More part-time work opportunities, increased female workforce participation, and people delaying retirement (working longer).

What is underemployment

Someone who is currently employed but would like, and is available, to work additional hours.

What two groups does the ABS headline measure of underemployment capture

(a) Part-time workers (usually <35 hrs/week) working below their preferred hours and available for more; (b) full-time workers (usually ≥35 hrs/week) who worked fewer hours due to insufficient work or being stood down.

What is the underutilisation rate

The sum of the unemployment rate and the underemployment rate — a broader measure of spare labour capacity than unemployment alone.

What is the formula for the underutilisation rate

Underutilisation rate = Unemployment rate + Underemployment rate.

What is the formula for the labour force

Labour force = Employed + Unemployed.

What is the formula for the unemployment rate

[ \text{Unemployment rate} = \dfrac{\text{Unemployed}}{\text{Labour Force}} \times 100 ]

What are the preset steps to calculate the labour force, participation rate, and unemployment rate from raw data

1. Labour force = Employed + Unemployed.
   2. Participation rate = (Labour force ÷ Working age population) × 100.
   3. Unemployment rate = (Unemployed ÷ Labour force) × 100.
   4. Underutilisation rate = Unemployment rate + Underemployment rate.

Given 12.6 million employed, 0.7 million unemployed, and a working age population of 20 million, what are the preset steps to find the unemployment rate

1. Labour force = 12.6m + 0.7m = 13.3m.
   2. Unemployment rate = (0.7m ÷ 13.3m) × 100 ≈ 5.26%.

What is full employment (the natural rate of unemployment)

The minimum level of unemployment achievable given the current characteristics of the labour market; currently considered to be around 4% in Australia.

At full employment, what is the level of cyclical unemployment

0% — the economy is operating at or near full capacity.

What are the two reasons full employment (0% unemployment) is never actually achievable

1. The presence of frictional unemployment (workers transitioning between jobs).
   2. Persistent structural unemployment (due to changing technology/industry structure).

How does frictional unemployment behave in a boom versus a trough

In a boom, frictional UE tends to be higher (people are more confident to find a new/better job); in a trough, it tends to be lower (people are cautious about job changing). Structural UE remains steady in both.

What happens as the unemployment rate falls close to the natural rate (full employment)

Spare capacity decreases; businesses struggle to find suitable workers, offer higher wages, and raise prices to cover higher labour costs — leading to increased spending and rising inflation.

What happens as the unemployment rate rises above full employment

Spare capacity increases; demand for workers falls, creating downward pressure on wages growth and prices, and inflation falls.

What is the NAIRU

The Non-Accelerating Inflation Rate of Unemployment — the lowest unemployment rate sustainable without causing wages growth and inflation to rise; a medium-to-long-run concept used by the RBA to gauge full employment.

Can the NAIRU be directly observed

No — it cannot be observed directly, but is inferred through indicators such as wages growth, job advertisements, and hiring intentions.