the Determinants of Non-tradables Inflation

The Reserve Bank’s inflation target is specified in terms of CPI inflation. However, in understanding and forecasting developments in overall inflation, it can be useful to examine separate components of the CPI basket. In a small open economy such as Australia, the basket of goods and services consumed by households can be divided into ‘non-tradable’ items and ‘tradable’ items. Non-tradable items are exposed to a low degree of international competition. This includes many services that can (in most cases) only be provided locally, such as hairdressing, medical treatment or electricity. The prices of these items should be driven mainly by domestic developments. Therefore, inflation for non-tradable items should provide a relatively good sense of the extent to which demand exceeds (or falls short) of supply in the domestic economy. In contrast, tradable items are much more exposed to international competition. This includes many imported manufactured goods such as televisions and computers, as well as some food items and services such as international travel. The prices of these items should be less influenced by conditions in the Australian economy, and more affected by prices set on world markets and fluctuations in the exchange rate.