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Treasury yet to ‘wargame’ stagflation scenario, downplays risks

By Charbel Kadib
4 minute read

The department has not stress tested a stagflation scenario, the Treasury secretary has told the Senate, despite persistently high inflation and a looming economic downturn.

Annualised inflation remains well above the 2–3 per cent target range, closing the March quarter at 7 per cent.

This was despite aggressive monetary policy tightening from the Reserve Bank of Australia (RBA), which has lifted the cash rate by a cumulative 375 bps since May 2022.

The latest economic indicators also point to deteriorating economic conditions, with the unemployment rate increasing beyond market expectations to 3.7 per cent.


Consumer spending has also eased, with retail sales flat in April and slowing to 4.2 per cent in annual terms.

“Sticky” inflation and mounting evidence of a looming economic downturn have rekindled stagflation speculation.

In his appearance before the Senate economics legislation committee on Tuesday (30 May), Treasury secretary Steven Kennedy was asked if the department had formally assessed stagflation risks via a “wargaming” exercise.

But Dr Kennedy revealed Treasury has not sought to replicate a 1970s-style stagflation crisis to assess the economy’s subsequent response.

The Treasury secretary downplayed risks but acknowledged a scenario in which such stagflation could emerge amid a wage/price spiral and “persistent stickiness” to the supply shock.

But he said these risks are “low”, given structural changes to monetary policy activity, actioned following the last stagflation crisis in the mid-1970s.

“I think the circumstances under which stagflation arose in the past are quite different today, including flexibility in markets, but particularly the independence of central banks, not only here, but also around the world,” he told the Senate.

“…It’s very difficult [under] current institutional arrangements to generate [stagflation] because you get a monetary policy reaction.”

Stephen Koukoulas, managing director of Market Economics, agrees, stating current economic conditions do not reflect a typical stagflation scenario.

“To me, it seems as if the conditions for a genuine concern about stagflation just aren’t there,” he told InvestorDaily.

“We’ve already seen that inflation is starting to decelerate, and if the forecasts from the RBA and from the US Federal Reserve are correct, it’s just a matter of time before we see inflation back to levels that are consistent with the various central bank targets.

“…All the indicators of inflation are turning in the right direction, so I think stagflation is a low probability, particularly if we do get six months of very weak growth.”

Prolonged rate pause ahead

Mr Koukoulas went on to claim recent run of economic data suggests the RBA “has done enough” to curb inflation.

He said he expects the central bank to keep the cash rate on hold at its next monetary policy board meeting on Tuesday, 6 June.

“Clearly [a rate hike] would cause a hard landing and clearly get inflation lower, too,” he said.

“But I don’t think we need to have a hard landing to get inflation down.

“…You’d have to say the probability favours putting rates on hold.”

He said he can envisage the RBA “sitting tight for a few months” to observe how the economy evolves.

As for the timing of future rate cuts, Mr Koukoulas said he does not expect relief until the “early part of 2024”.

“I have the economy weakening sufficiently, the unemployment rate will be heading towards 4.5 per cent, and we’ll have inflation back towards target,” he said.

The economist said the RBA may action as much as 150 bps in rate cuts over the course of 2024.

RBA governor Philip Lowe has previously stated talk of rate cuts is “premature”.

“Remember, we’ve got the highest inflation rate in 30 years, the lowest unemployment rate in 50 years, and still two years before we get inflation back to the top of the target range,” he said during an address to the National Press Club.

“So, I think it’s too early, way too early, to be talking about interest rate cuts and the balance of risk lie to further rate rises, but it will depend upon the data.”

He said the central bank is prepared to keep rates “higher for longer”.

“If we need to keep interest rates higher for longer to make sure that inflation comes back to 2 to 3 per cent range [in a] reasonable time, we’ll do that,” he said.

“But that will be determined by the flow of events.”

Treasury yet to ‘wargame’ stagflation scenario, downplays risks

The department has not stress tested a stagflation scenario, the Treasury secretary has told the Senate, despite persistently high inflation and a looming economic downturn.

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