Australia braces for stagflation: economists sound the alarm

australia's economic outlook is growing increasingly precarious, with two of the nation's most respected economists warning of a potential stagflationary spiral. The escalating global energy crisis, fueled by the ongoing conflict in the Middle East, is emerging as the primary catalyst for concern, threatening to derail the country's economic stability.

Former treasury secretary warns of rising risk

Dr. Martin Parkinson, who served as Treasury Secretary from 2011 to 2015, acknowledged the risk of stagflation—a debilitating combination of economic stagnation and high inflation—is real, though not yet fully realized. His assessment echoes that of Professor Bob Gregory, a former Reserve Bank board member, who believes australia is already experiencing the early stages of this unwelcome phenomenon. The common thread linking their concerns? A severely disrupted global energy market.

“The forces that have been unleashed, and the consequences of this war, are going to have long-lasting effects,” Parkinson stated last week, underscoring the gravity of the situation. The war's impact on energy supplies and global supply chains has injected inflationary pressures that could prove difficult to manage, potentially leading to rising unemployment and a broader economic downturn. The specter of the 1970s – a decade marred by widespread stagflation – looms large, though both economists suggest the current scenario, while concerning, may not reach those levels.

Echoes of the 1970s: a familiar threat

Professor Gregory, who actively participated in policy debates during the 1970s stagflation crisis, recently discussed the parallels between that era and today’s oil shock on ABC’s “The Economy, Stupid” podcast. He noted that while the scale of the crisis might differ, the underlying dynamics – a surge in energy prices colliding with a sluggish economy – are strikingly similar. “I think it will happen and it is happening,” Gregory declared, predicting a rise in both inflation and unemployment in the coming months. The pivotal question, he stressed, is the duration of the oil price surge.

The World Bank’s recent warning of impending global stagflation adds further weight to these anxieties. However, Gregory emphasizes that the current situation isn’t a mere replay of the 1970s, largely due to structural differences in the global economy. A swift resolution to the Middle Eastern conflict and a subsequent stabilization of oil prices could allow the Reserve Bank to weather the inflationary storm without aggressive intervention.

Rate hikes on the horizon: westpac’s prediction

Adding to the pressure, Westpac’s chief economist, Luci Ellis (formerly an assistant governor at the RBA), anticipates the Reserve Bank will implement three further interest rate hikes in May, June, and August, pushing the cash rate target to 4.85 percent. While the Albanese government’s temporary fuel excise reduction will offer some short-term relief from inflation, headline inflation is still projected to reach 5.4 percent in the June quarter, and unemployment is expected to climb to 5 percent.

Beyond rate hikes: exploring alternative strategies

The current crisis is prompting a re-evaluation of traditional inflation-fighting tools. Instead of solely relying on interest rate hikes, policymakers are considering alternative approaches—a lesson learned from past economic turbulence. The Fraser government’s attempt to control inflation in the 1970s through monetary targeting, and the Hawke Labor government’s subsequent adoption of the Prices and Incomes Accord, offer valuable insights.

Even bolder ideas are resurfacing. Commonwealth Bank CEO Matt Comyn has proposed a 15-25 percent tax on gas exports to fund business tax incentives, aiming to boost productivity. Treasurer Jim Chalmers faces a critical decision: will he embrace unconventional measures to avert stagflation, or will he stick to the conventional playbook?

The coming months will be crucial. The duration of the Middle East conflict and its impact on global energy markets will dictate australia’s economic fate. The government’s response – whether it chooses to experiment with novel policies or rely on traditional tools – will shape the nation’s trajectory for years to come.