RESEARCH PAPER NO. 878

UNDERLYING INFLATION IN AUSTRALIA: ARE THE EXISTING MEASURES SATISFACTORY?

ROBERT DIXON & G. C. LIM

JULY 2003

Department of Economics. University of Melbourne. Melbourne Victoria 3010 Australia

Along with a number of other central banks around the world the Reserve Bank of Australia has quite explicitly adopted an inflation target. Both the Bank and the Australian Government's statistical agency (the Australian Bureau of Statistics) report various measures of the underlying rate of inflation. The aim of this paper is to formulate criteria which an acceptable underlying rate must satisfy and then test to see whether either individually or in combination any of the current (CPI Excluding volatile items; CPI Market prices excluding volatile items; Weighted median and; Trimmed mean) or recently discarded (the Treasury underlying rate) measures of underlying inflation satisfy these criteria.  We find that for the period since inflation targeting began (in 1993) none of these underlying series satisfy all of the criteria we propose but that one series (the RBA's Trimmed mean series) does satisfy the sub-set which we refer to as our 'necessary criteria'. We then examine the results of an 'Unobserved Components' decomposition and argue that it provides useful information on underlying inflation in Australia.