Detailed Analysis: RBA's Inflation Target of 2-3% in 1991

This essay delves into the rationale behind the Reserve Bank of Australia's (RBA) decision in 1991 to establish an inflation target of 2-3% on average over the long term. It explains that the target aimed to allow price and wage adjustments without high inflation uncertainty, promoting economic stability. The essay discusses the benefits of a 2% inflation rate, such as lower interest rates and stimulating the economy, while also addressing potential issues like raising real interest rates and delaying consumer purchases. It highlights that the inflation target is a medium-term average, acknowledging diminishing inflationary pressure during weak economic demand. The essay further explores the advantages of a moderate inflation rate, including facilitating wage adjustments and fostering economic growth, while also cautioning against the risks of deflation and the limitations of monetary policy in such environments. References to relevant academic sources support the analysis.

Running head: ECONOMICS
Economics
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ECONOMICS
Why did the RBA in 1991 choose to set an inflation target of 2-3% on average over the
long-term?
The Governor of Australia have agreed to set the target of the inflation at two to three
percent on average over time. The inflation rate is targeted at 2 percent since it will be
allowing the prices and wages to adjust without causing any kind of uncertainty of the high
rate of inflation. The 2 percent inflation rate always help the economy for maintaining
stability and reliability for the public. When the rate of inflation will be low, it will be leading
to lower rate of interest. The 2 percent interest rate which will be helping the reserve bank for
stimulating the economy.
There will be various problem with low interest rate such as it will be raising the real
rate of interest, delay purchasing and lower inflation also means low growth. When the level
of inflation will be too low, it will also be quite hard for prices and wages to adjust. The
inflation target is defined as a medium-term average rather than as a rate that must be held at
all time. When the demand in the economy will be weak, the inflationary pressure will be
diminishing. The inflation targeting is a kind of monetary policy where the central bank will
be setting a specific rate. Inflation targeting is a kind of monetary policy regime which the
central bank uses for expliciting target inflation for the medium term. The 2 percent rate of
inflation is sometimes good for the economy since deflation is very damaging in the
economy. It can also lead to low rate of spending of the consumers and lead to lower growth
in nature. The two percent inflation is the moderate rate of inflation will be allowing relative
wages for adjusting. The moderate rate of inflation are sometimes also a sign of healthy
economy.
The economic growth also results as a result of inflation. When there will be presence
of inflation in the society, the businesses will be able to raise the price of the commodities.

ECONOMICS
When there will be moderate amount of inflation in the economy, the workers will be
demanding higher wages since they will need more pay to keep up with the rapid rise in the
cost of living. When price will fall the consumers will be delaying the purchase of goods and
further they will be cheaper in future. The real wages will be quite high in nature. The reserve
bank of Australia will be using the harmonized index for keeping the rate of inflation at 2
percent. There is also a risk of deflation in the economy which is also quite harmful in
nature. The monetary policy also relies on the rate of interest for stimulating demand.
Although in case of the deflationary environment the rate of interest will be moving towards
zero as monetary policy will be ineffective in nature

ECONOMICS
Reference list
Berument, H., & Froyen, R. T. (2015). Monetary policy and interest rates under inflation
targeting in Australia and New Zealand. New Zealand Economic Papers, 49(2), 171-
188.
Gillitzer, C., & Simon, J. (2015). Inflation Targeting: A Victim of Its Own Success?.
International Journal of Central Banking, 11(4), 259-287.
Moore, A. (2016). Measures of Inflation Expectations in Australia. RBA Bulletin, December,
23-31.
Svensson, L. E. (2015). The possible unemployment cost of average inflation below a
credible target. American Economic Journal: Macroeconomics, 7(1), 258-96.