Stagflation: what is it and is it really happening in Australia? | Australian economy
Amid the clatter of crashing markets, economists are haunted by the spectre of stagflation, an economic phenomenon not seen on a global scale since the 1970s.
But is stagflation really happening now? Here’s what you need to know.
What is stagflation?
It’s an ugly word to describe an ugly situation: when the economy is stagnant, either barely growing or even shrinking, while inflation is rampant.
Dr Sarah Hunter, a senior economist and partner at KPMG, says the 1970s was the last time the world as a whole experienced stagflation that went on for years.
“A lot of countries went through a time where their pace of GDP growth was really very slow, or even in some cases broadly flat or they had contractions, and we had really elevated rates of inflation at the same time,” she says.
What causes it?
In the 70s, the behaviour of the Organisation of the Petroleum Exporting Countries (Opec), which is a group of oil producing countries, helped spark stagflation.
At the time, Opec was more powerful than it is today because members were more united in setting supply levels, which in turn are a major influence on price. They are less likely to act in unison today, and Russia, which has dramatically increased oil production since the 1970s to become the third-largest producer in the world, is not a member.
“One of the triggers in the 1970s was a commodity price shock, particularly oil prices,” Hunter says.
“So in the early 1970s, the Opec group significantly restricted the supply of oil to the global market and this caused an oil price shock, the oil price rose really rapidly through that period. And so that kicked off inflation.
“Obviously if we’re looking at what’s happening right now – for very different reasons – we do have similar types of shocks playing through commodity markets globally, obviously, again, related back to the conflict in Ukraine and what’s happening there.
“That’s a very different trigger, but the same kind of outcome.”
Is it happening now?
Opinions are divided.
Markets are spooked by the prospect, with the ASX plunging 12% so far this year, led down by speculative tech and financial stocks. They are also suffering because, as interest rates increase, investors are less willing to take a punt on companies that don’t have a clear pathway towards making a profit within the next few years.
In a note in late April, the chief economist of global insurer Swiss Re, Jerome Haegeli, said that “stagflation is fully back on the radar and we now need to be particularly disciplined” in fighting it.
However, he said a full-blown repeat of history was unlikely because economic conditions are very different. This makes stagflation less likely but an economic crash more likely.
“Central banks are acting very forcefully to keep the downside risk of 1970s-style stagflation at bay,” he said.
“Consequently, and with aggressive Fed rate hiking ahead, a soft landing in the US looks to be wishful thinking.”
Hunter says the way governments run the economy now is very different to the way they were run in the 1970s because central banks now target inflation rather than employment.
Inflation targeting refers to central banks using their control of official interest rates as a lever to try to keep inflation at a certain level – in the case of the Reserve Bank of Australia between 2% and 3%.
When central banks raise interest rates, it usually dampens inflation.
But in the 1970s, “we didn’t have independent central banks, and we certainly didn’t have central banks that were inflation targeting either,” Hunter says.
“The policy settings and the policy framework then was very much achieving absolute minimum rates of unemployment. So really driving the economy hard to achieve that.”
Wages growth was much higher in the 1970s, when union power in the workplace was much stronger.
In 1977, the then prime minister, Malcolm Fraser, and his minister for business and consumer affairs, John Howard, tried to freeze wages to break the inflationary cycle of wages and prices going up, but were unsuccessful.
Both inflation and unemployment – together, the so-called “misery index” – rose over the next few years with the economy only recovering a full head of steam when the 80s boom arrived during the Hawke government.
Hunter also points out that while the economy has some stagflationary features right now, growth is currently strongly rebounding from the Covid recession.
“I do think we’re going to see a slowdown in growth momentum though, certainly from the June quarter, where we are at the moment, and through the rest of this year into 2023,” she says.
“In the global economy, I do think that we’ll get back to a growth environment and a relatively low inflation growth environment as we go through 2024 and 25.”
Either way, Australian households are feeling the pinch
Whether or not we are actually in stagflation, Australian workers are going to suffer as their wages fail to keep up with inflation, which the RBA governor, Philip Lowe, expects may hit 7% – a prediction that may be optimistic if his recent track record of significantly underestimating inflation holds true.
At the same time, Lowe’s interest rate hikes, which are designed to curb inflation in the longer run, have put an immediate financial squeeze on households with mortgages because Australia’s commercial banks have been lightning quick to pass on the full impost.
A minimum wage increase of 5.2%, announced on Wednesday by the Fair Work Commission, will be above what many other workers receive this year, Hunter says, and “it’s not going to be, likely, enough”.
“Generally speaking, many, many people are going to be seeing their pay go up by a bit, but the cost of that is probably going to move by more, so in real terms this year they’re going to be made worse off,” she says.
“For a lot of people that’s how what’s happening at the moment will be felt – things are getting more expensive, your pay, your income, is not keeping up with it. And that’s just a bit challenging as an environment to be living in.
“This might prompt many people to have to look at what they spend their money on, and maybe having to make some cutbacks here and there.”