inflation help! (1 Viewer)

[starryXnite]

I wondering if anyone knows the effect GST had on inflation?
I can't find it in my textbook
thanks in advance

 

[spence]

it added to most prices. that was inflation. didn't think that needed explaining tbh

 

[starryXnite]

~thanks

 

[gnrlies]

Go an check some time series data on the CPI. Should be easily available on the RBA website. You will find some very interesting phenomena. Inflation went up to around 6% from memory. Think why this was the case. It holds some interesting insights to the formation of inflationary expectations particularly given that it very quickly (within one year) went back to the pre GST level of inflation. But please, don't take my word for it, whack the numbers into excel and see for yourself. I advise every HSC student to become familiar with such time series data.

 

[bell531]

Go an check some time series data on the CPI. Should be easily available on the RBA website. You will find some very interesting phenomena. Inflation went up to around 6% from memory. Think why this was the case. It holds some interesting insights to the formation of inflationary expectations particularly given that it very quickly (within one year) went back to the pre GST level of inflation. But please, don't take my word for it, whack the numbers into excel and see for yourself. I advise every HSC student to become familiar with such time series data.

Any reason why inflation was so much higher than the actual increase caused by the tax? i.e. GST only added one percent or something right?

 

[gnrlies]

Any reason why inflation was so much higher than the actual increase caused by the tax? i.e. GST only added one percent or something right?

Well actually the GST was 10% so this would imply 10% inflation.

This result was produced by the dynamic relationship between actual inflation and inflationary expectations. Because the 10% rise was only temporary, inflationary expectations did not jump by the full amount (although they did rise).

 

[electrolysis]

Well actually the GST was 10% so this would imply 10% inflation.

This result was produced by the dynamic relationship between actual inflation and inflationary expectations. Because the 10% rise was only temporary, inflationary expectations did not jump by the full amount (although they did rise).

woah, I didnt get this, so why didnt inflation go up by 10%?? and how come its temporary? the GST is still in place...

 

[gnrlies]

woah, I didnt get this, so why didnt inflation go up by 10%?? and how come its temporary? the GST is still in place...

I will make a few points in answer to your question.

1 - The GST is a tax. The CPI does not include consumption taxes when calculating the price of this hypothetical basket of goods and services. Subsequently the introduction of the GST should theoretically have no impact on the CPI.

2 - As stated above theoretically the GST has no impact on the CPI, however lets imagine for a moment that the CPI did include the GST. The reason why it's impact would only be temporary is because inflation refers to a sustained increase in the general level of prices. For for a 10% GST to produce 10% inflation permanantly, this would require the GST to increase prices every year by 10% (kind of like 1.1 x 1.1 x 1.1 x 1.1 and so on).

3. If the GST theoretically had no impact on the CPI, then why did inflation increase to over 6%? Well as I said earlier it has to do with inflationary expectations. Economists deal with forward looking models that look to future values of key variables when formulating its current value. A common example is inflation. Inflation today depends on the expected inflation of tommorow. If you perceive inflation to increase, you will ask for higher wages, possibly charge a higher price for your products etc etc. This creates a feedback loop where todays inflation is dependent on tommorows expected inflation. When the GST was implemented, inflationary expectations increased and it increased to 6%. There is no rational explanation for this (given that income tax cuts were given to offset the effects of inflation), but it is intuitive to think that if prices increased by 10% there would still be a lot of people wanting a pay rise etc etc. The psychology of the situation also gave businesses the opportunity to increase their prices by an amount in excess of the GST.

 

[electrolysis]

^ ah okies, I get that
however, just wanted to get something clear, you said that the GST did not directly correlate with a rise in CPI, but the GST would've increased prices that are part of this hypothetical basket of goods and services, hence the end effect is that inflation will go up... ?

 

[bell531]

Well actually the GST was 10% so this would imply 10% inflation.

This result was produced by the dynamic relationship between actual inflation and inflationary expectations. Because the 10% rise was only temporary, inflationary expectations did not jump by the full amount (although they did rise).

BAh!!1

Well that explains that then.

 

[gnrlies]

^ ah okies, I get that
however, just wanted to get something clear, you said that the GST did not directly correlate with a rise in CPI, but the GST would've increased prices that are part of this hypothetical basket of goods and services, hence the end effect is that inflation will go up... ?

Yes but remember the GST is a tax and is not included in the CPI. So the price of bannanas may have increased by 10% as far as your wallet is concerned, however as far as the CPI is concerned only the ex-GST price is included. This is also true of input costs because firms claim GST credits on their inputs.

 

[electrolysis]

Yes but remember the GST is a tax and is not included in the CPI. So the price of bannanas may have increased by 10% as far as your wallet is concerned, however as far as the CPI is concerned only the ex-GST price is included. This is also true of input costs because firms claim GST credits on their inputs.

ohhhh, now I get it, so they take the ex-GST price...
thanks for clarifying that