Is Australia about to experience 'stagflation'?

The head of the World Bank has warned the global economy is at risk of experiencing inflation's sluggish cousin. Again.

The head of the World Bank has warned the global economy is at risk of experiencing inflation's sluggish cousin. Again.

Economists are suddenly worried about stagflation and whether it could reach Australian shores. 

Late Tuesday night the head of the World Bank warned stagflation was a real possibility for low and middle-income countries. 

It's a concept that hasn't seen the light of day since the 1970s and early 1980s, defined by a sudden rise in the price of oil, really high inflation and low economic growth. 

Stagflation is basically unemployment paired with high inflation rates (and, in turn, rising interest rates), which leads to a downturn in the overall economy (= stagnation).

"Even if a global recession is averted, the pain of stagflation could persist for several years – unless major supply increases are set in motion," World Bank president David Malpass said.

For stagflation to occur in Australia, real wages and unemployment would have to rise. But experts say, even with the unemployment rate at lows of 3.9%, it isn't so far-fetched that we could see stagflation happen here.

Here's how it could work:

Take a small business with five employees. They have a bit of debt and a home loan to pay.

➡️ Now, the price of lettuce, chicken, electricity and gas has gone up (that's inflation)

➡️ In the meantime, they have a competing business nearby which means they cant put prices up as much as they'd like to. So their profits fall.

➡️ The business owner realises they are taking home less money and they start wondering if they could pay their mortage.

➡️ So they cut costs. Putting cabbage instead off lettuce into a burger (like KFC) isn't enough, so they get rid of one staff member. 

➡️ The four people that keep their jobs have to work more hours, and one person is unemployed.

➡️ This is the beginning of stagflation. 

Unemployment would need to rise to 6 to 10% for stagflation to occur, and the Central Bank would essentially have to "do nothing" when they saw unemployment starting to increase, USyd Associate Professor David Kim said.

Another element of stagflation is wage rises, which is driven by inflation and a shortage of skilled labor as employers pay more to keep staff. 

Assoc. Prof. Kim said stagflation was a possibility for Australia and could happen if we had a "wage price spiral". That is, if wages rise due to inflation (either because the government increases the minimum wage or unions demanded higher wages) it would in turn lead to more inflation and another wage rise.

"The large part of inflation is due to wage inflation ... If this wage price spiral continues, then yes, stagflation can occur," he said.

"It's only a matter of time for the wages across the entire economy to increase in the next probably six to 12 months."

What happens if there is stagflation?

Economist Richard Holden was less sure stagflation would happen in Australia because, he said, "monetary policy has changed a great deal since the 1970s" and the RBA would raise interest rates "to get things (high inflation) back under control".

"Are we headed for a repeat of the 1970s? No, I don't think so ...  (But) are we are we in a period of time where we're going to have, in Australia, pretty high inflation, like 7%, and is economic growth and employment going to come under pressure? Yeah, I think that is what's going on."

If "1970s style" stagflation occurred however, Holden said it would be "really painful" and that the pain would continue until "interest rates go up to a high enough level to get inflation down to 3%".

"Unemployment would go up a lot, like 10% unemployment, inflation would be really high, interest rates would go up so there'd be a lot of pain or mortgage holders, mortgage rates at 10%. It would be really ugly and that's why policy makers want to avoid it."

What are the experts saying?

What followed pockets of stagflation in the past was a recession. That isn't a concern for Australia right now according to the government and business leaders. 

"That's not on my list of fears for our domestic economy. I genuinely believe we have, certainly in the medium term, more opportunities than challenges," Treasurer Jim Chalmers said on Wednesday. 

His optimism was backed up by the Business Council of Australia boss Jennifer Westacott.

"I agree with the Treasurer, I don't believe we are heading for a recession but we have got to do something about labour shortages because they will slow activity down, not speed it up. We have got to get out of this sense of 'that's what will push wages up', well, it might in some sectors but in the short term only and ultimately that starts to cannibalise our capacity to grow our way out of this," Westacott said.

So for now, it seems the Australian economy may be going stag instead of suffering stagflation.