BEN HARVEY: Why stagflation is far worse than inflation and why the risk is rising

How’s this for a fun fact that you might be able to use at your next quiz night — the Reserve Bank of Australia is governed by three boards, not one.

OK, we have stretched the definition of fun to breaking point, so let’s call it an interesting fact.

Still too much of a stretch? Probably. It’s just a fact. And if it is ever asked at a quiz night then everyone is in for a very boring evening.

I have been following Reserve Bank announcements for more than a quarter of a century and I had no idea there was more than one board until a few days ago when I went searching for a particular document.

The governance board oversees the bank’s operational framework, the payments system board examines how we pay for stuff and the monetary policy board sets interest rates.

Needless to say, we don’t care about the first two.

The monetary board comprises nine members and is chaired by the big kahuna, Michele Bullock. Five members must be present to get a quorum and they meet every six weeks, deliberating for two days straight.

At the end of the second day — always a Tuesday and always after enough PowerPoint slides to kill mortal souls — we get a rates decision.

Most of us forget about the RBA for the next five weeks and six days but there are a few smartie pants out there who wait impatiently for a statement which is issued a fortnight after the rates decision is made.

That statement — the minutes of the most recent meeting — is examined in minute detail by professional investors.

Money managers care less about what the rates decision is and more about why. If you understand why then you have a better chance of predicting the next move and being ahead of the curve is where all the money is.

Investment banks have been known to employ body language experts and psychologists to interpret what Reserve Bank governors are really thinking when they make speeches and you can bet London to a brick that an AI language analysis is done on the minutes as soon as they are posted on the RBA website.

Notes from the Reserve’s May meeting, at which rates were cut by 25 basis points (that’s 0.25 percentage points) were made public on Tuesday.

“Bank board wants path of least regret through Trump’s trade war” was the gist of most headlines.

Spoiler alert — when the word “regret” is in the top line, you know the story’s not going to have a happy ending.

For the past couple of years, the cause of regret has been high inflation.

That’s still a problem. We didn’t need the Reserve to tell us that because consumer price index figures released just prior to last month’s meeting showed the inflation genie is reluctant to get back into the bottle.

Headline inflation remained steady but the problem was underlying inflation — which strips out volatile items such as seasonal holiday travel to Bonnie Doon.

Here’s why Tuesday’s Reserve minutes were important. It appears rates were cut not because inflation is under control (it’s not) but because the economy is starting to smell a little like almonds.

“A 25 basis point reduction would ensure that monetary policy settings remained predictable at a time of heightened uncertainty, given market expectations,” the minutes stated.

“And it would leave the board well-placed to respond as needed as the economy evolved.”

The RBA also said it would “respond decisively to international developments if they were to have material implications for activity and inflation” in Australia.

Sounds benign, right?

Reserve Bank statements always are. The language is typically so muted you could fall asleep reading an announcement even it was documenting a fresh global financial crisis caused by a Chinese invasion of Taiwan.

The sedate wording belies emerging evidence that, for the first time since the 1970s, we’re facing a nightmare financial scenario that keeps politicians and economists up at night.

It turns out there is something far worse than inflation.

Stagflation occurs when an economy stalls and people lose their jobs but prices keep going up.

That’s very unusual because when people stop shopping retailers generally cut prices.

But what if they can’t because the cost of goods is so high there is very little margin to play with?

Last time we saw this situation was 50 years ago during the OPEC oil crisis.

It ended with an unholy economic trinity of high prices, growing unemployment and a lacklustre economy.

We’ve got two of those ingredients already in inflation and poor economic growth (the day after the Reserve minutes were published the Australian Bureau of Statistics reported that the economy grew by a paltry 0.2 per cent in the March quarter, and 1.3 per cent through the year).

All three of the Reserve’s boards will be watching the unemployment rate very closely because if that starts going up Bullock and co are screwed whichever way they turn.

Raise rates to bring inflation down and the economy goes into recession, throwing more people on the dole.

Lower rates to stimulate economic activity and prices go through the roof even more.

Keep rates steady and we’re stuck in economic quicksand, possibly for years.