RBA’s Sarah Hunter warns Middle East war fuel prices risk 1980s-style stagflation in Australia

The Reserve Bank’s head of economic research has warned Australia faces 1980s-style stagflation the longer the Iran war pushes up fuel prices, as Treasurer Jim Chalmers insists a recession can be avoided.

Sarah Hunter, an assistant governor in charge of economic research, said the RBA’s credibility would be at risk if inflation and unemployment both soared, as they did more than four decades ago in the years after another global oil shock.

“Inflation expectations have to be the north star in all of this - the credibility of the institution,” she told an International Monetary Fund panel discussion in Washington on Friday morning.

“If we lose that, we go back to a world of the 1970s, the 1980s, where it’s much more costly.”

Just half an hour after her appearance, Dr Chalmers told reporters in Washington a recession could be avoided in Australia.

“Our current expectation is that the economy will continue to grow, but more slowly,” he told reporters.

“I think it’s self-evident when you have an oil shock of this magnitude and this nature that it will have impacts on inflation and on growth simultaneously.”

His Labor colleague Shayne Neumann, who also hails from south-east Queensland, is concerned higher interest rates will worsen mortgage stress for those who recently bought a home, particularly in Ipswich near Brisbane which has seen some of Australia’s biggest house price rises.

“Of course, interest rate rises hurt people with mortgages, adversely impact upon them,” he told The Nightly on Friday.

“There wouldn’t be a politician around the country that wouldn’t have some concern about these issues.”

Dr Hunter admitted the Reserve Bank would struggle to get inflation back within its 2-3 per cent target, with the consumer price index already at 3.7 per cent in February before the US strikes on Iran.

“Relative price shocks are not great for inflation targeting central banks - they make the job really, really hard, much harder than when we get a demand shock, either positive or negative,” she said.

“For me, it’s all about what that does to the monetary policy tradeoff. How much of an impact on inflation does it have and inflation expectations and how much of an impact on our activity?”

While unemployment in March remained steady at 4.3 per cent, Dr Hunter warned the jobless level was likely to be a lot higher.

“If you start from a tight economy, you’re already at full employment or beyond it, the potential for these second-round effects is probably larger,” she said.

“That’s on the inflation side of the ledger but of course on the other side, this is a real income shock.

“Many households around the world, in Australia, in all countries will be struggling with and grappling with higher fuel prices - they will be making some really hard tradeoffs and that could well, in many countries, slow growth down, put pressure on our unemployment rate and feed through into our labour market more broadly.”

She also admitted the Reserve Bank was still learning how to cope with the worst global oil shock since the 1970s.

“If things are changing and evolving rapidly, but the job gets harder because we’re not going to fully understand what’s happening,” Dr Hunter said.

“Certainly, from a monetary policy perspective, these trends are going to make it harder for us to understand what’s going on in the economy.

“Our role as central bankers is stability - stability is more important than ever.”

Australia experienced a deep recession in 1982 and 1983 which saw unemployment and inflation both simultaneously hit double-digit figures.