Deflation v disinflation   Why inflation is bad   Goal of low inflation   Why the RBA targets 2-3%   Measurement of inflation    Headline v underlying   Inflationary expectations

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 Course notes quick navigation

1 Introductory concepts 2  Market mechanism  3 Elasticities  4 Market structures 5  Market failures  6  Macro economic activity/eco growth  7 Inflation 8  Employment & unemployment  9  External Stability  10  Income distribution 11.Factors affecting economy  12  Fiscal/Budgetary policy  13  Monetary Policy   14 Aggregate Supply Policies  15 The Policy Mix

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headline and underlying rates of inflation

The inflation rates calculated above are referred to as the headline rate of inflation.  This means that they capture the price movements of all goods and services contained in the CPI.  Accordingly, the hypothetical 50% inflation rate on the previous page refers to the ‘headline rate of inflation’, or simply ‘headline inflation’.  

The Governments will also seek to gain a picture of the underlying inflationary pressures that exist in the economy in order to assist in policy formulation.  The ABS and the RBA each produce a set of inflation statistics that are derived from the original CPI, but exclude various prices in order to arrive at an ‘underlying rate of inflation.’  This is sometimes referred to as the ‘core rate of inflation’ and will be particularly important for the RBA when deliberating on changes to monetary policy settings.  

The ABS calculates an inflation figure based on the normal CPI but excluding the ‘volatile items’ of fruit and vegetables and fuel.  This underlying measure is referred to as the ‘CPI all groups excluding volatile items’.  It is important to note that the underlying rate of inflation will be below the CPI headline rate when the prices of volatile items are rising and will be higher than the headline rate when these volatile prices are falling.  For example, following the floods and cyclone in early 2011, the prices of many fruit and vegetables rose dramatically, pushing the CPI (headline rate) up to an annual 3.5% in the middle of 2011.  However, these price rises were excluded from underlying measures because they were one-off events and the CPI excluding volatile items rose by only 2.6%.  One year later, prices of these fruit and vegetable items returned to more normal levels, which resulted in the headline rate falling to only 1.2%.  Again, the price falls within the fruit and vegetable category were not included in the underlying measures, resulting in the CPI excluding volatile items rising by 1.8% - clearly higher than the headline rate.  

The RBA calculates two underlying measures and then averages these to arrive at the RBA’s core or underlying rate of inflation.  First, the RBA’s ‘trimmed mean’ involves the prices of all CPI items but removing the top 15% of goods and services whose prices increased the most and the bottom 15% of goods and services whose prices increased the least.  It therefore includes price changes of only 70% of the goods and services in the CPI.  The ‘weighted median’ involves using the price change that sits in the middle of the range.  

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