Inflation Propagation in Production

ABSTRACT Background Inflationary pressures in an increasingly interconnected production system reflect not only aggregate or isolated sectoral shocks but also their propagation through supply‐chain networks. Methods This paper examines the mechanisms underlying inflation transmission in a small open economy, using industry‐level data for Australian manufacturing from 1995 to 2023. Inflation connectedness is quantified using both static and time‐varying Diebold‐Yilmaz forecast error variance decompositions, and linked to domestic and imported input‐output structures. Results Cross‐industry spillovers are economically substantial and time‐varying, accounting for 44%–61% of total producer price inflation variability. Linking these spillovers to production structures shows that inflation transmission is highly asymmetric and concentrated in upstream industries with high reliance on imported inputs, particularly fuel‐ and chemical‐related sectors. Policy Implications The results highlight the importance of production‐network exposure for inflation dynamics and have implications for inflation monitoring, supply‐chain resilience and policy design in small open economies.