. this increase in labour costs coincided with a period of slower growth in labour productivity. since 2005, estimated labour productivity growth has averaged less than ½ per cent per year, compared with average growth of 2 per cent over the 1990s. the reasons for this slowdown are not fully understood, although it may partly be a result of the high commodity prices that have allowed lower quality and / or more costly mines to be developed. in any case, productivity growth will need to pick up again if our living standards are to improve at the rate we have become accustomed to over the past two decades. this is a major challenge facing both the private and public sectors. looking back to the recent cycle in inflation, it is clear that developments in unit labour costs had a significant role, both in contributing to the increase in inflation and then to its decline. but they provide only a partial explanation, and alone cannot explain why inflation picked up so sharply in 2007 after having been stable over the preceding few years. one possible explanation for this pattern is that there is some threshold in capacity utilisation which when crossed causes inflation to increase very quickly. an alternative explanation is that the short - run dynamics of underlying inflation were influenced by other factors during this period. it is difficult to formally test these two explanations, but other factors do appear to have played a significant role. of these, developments in housing costs were perhaps the most important. housing cost inflation currently, housing - related costs – including rents, utilities and the cost of building new dwellings – account for around 20 per cent of the cpi, the largest share of any single group. broadly speaking, the housing component of the cpi shows the same general pattern as that in underlying inflation, although the recent moderation is less pronounced ( graph 6 ). bis central bankers ’ speeches graph 6 a couple of factors are important in explaining this general pattern. the first is that the large run - up in australian house prices that was driven by the adjustment to low inflation ended in late 2003. when the housing boom came to an end, building cost inflation came down and growth in rents was subdued for a few years. these outcomes helped hold down overall inflation rates during this period. but by 2007, the cycle had again turned, with building costs rising more quickly and growth in rents accelerating. this faster growth in rents reflected the changing balance of demand and supply in the rental market, with strong population growth coinciding with relatively slow expansion of supply. the second factor has been utilities prices. during

the middle years of the 2000s utilities prices were increasing at an average rate of 4 per cent, which was slightly lower than that in the previous few years. then from 2007, utilities price inflation accelerated sharply. the proximate cause was the regulatory decisions allowing double - digit price increases, partly to help fund infrastructure investment, particularly for the distribution of electricity. but a deeper cause was the low levels of investment in previous years, which meant that the capacity of the system to distribute electricity had not kept pace with the growth in demand, particularly during hot weather. 4 while these developments in rents and utilities do help explain the particular dynamics of inflation over the recent cycle, they also demonstrate that when the economy is operating up against supply constraints, all sorts of prices – and not just the price of labour – start rising more quickly. international factors the third issue that i would like to touch on is the role of international factors. looking at headline inflation rates across countries over recent years, there is a deal of similarity in the movements ( graph 7 ). many countries in both asia and the north atlantic experienced increases in headline inflation rates in 2007 and 2008 and many experienced for further details, see plumb m and k davis ( 2010 ), “ developments in utilities prices ”, rba bulletin, december, pp 9 – 18. bis central bankers ’ speeches declines in late 2008 and in 2009. this co - movement partly reflects the large changes in global commodity prices over recent years. when global oil prices went up, they boosted the cpi in almost all countries, and when they went down during the financial crisis, they led to cpi inflation falling almost everywhere. movements in food prices had a similar global effect. graph 7 in terms of underlying inflation, we also see some co - movement across countries over recent years, although somewhat less than in headline inflation ( graph 8 ). when underlying inflation in australia was rising, so too were equivalent measures of underlying inflation in the united states, as were exclusion - based measures of core inflation in most asian countries. 5 similarly, measures of underlying inflation fell almost everywhere in the aftermath of the financial crisis, although there has been more dispersion recently. these common movements reflect the correlation in the business cycle across countries, as well as the flow - on effects of the large changes in global commodity prices to the prices of a wide range of final goods and services. trimmed mean measures of underlying inflation are not available for most countries in asia. bis central bankers ’ speeches graph 8 movements in