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What is stagflation, and why central banks fear the dreaded vortex

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As economies around the world face rising inflation and stagnant growth, the word stagflation has begun to circulate.

The World Bank overnight released a report which warned many countries will soon find it "hard to avoid" recession, and tucked inside it was the S word.

Here we look at what this economic term means, and whether or not Australia could be vulnerable.

READ MORE: First of Big Four banks passes on interest rate hike

So, what is stagflation?

Do you know anyone who lived through the 1970s? You could ask them.

Why the 70s?

Things were quite bleak back then, inflation running in the mid-teens, a weak job market, oil shocks and shortages, low economic growth. It goes on.

Okay, but can't you just tell me?

Some economists describe stagflation as a kind of dreaded vortex, where stagnation and inflation meet. It's when the economy doesn't grow, but the costs of living do.

READ MORE: Why lettuce and other vegetables are so expensive or not on shelves

But isn't that like right now?

Kind of. For some nations, stagflation is now a real risk. But in Australia, not yet.

According to the IMF, the Australian economy is expected to grow about 2.3 per cent this year, which is higher than many other advanced economies.

Dr Gonzalo Castex, a fiscal expert with UNSW, says "we haven't fully recovered from the pandemic" but the economy is in not bad shape, all things considered.

But what about our 5.1 per cent inflation?

Indeed. Castex calls that a potential "red flag" and reckons our inflation is "high".

"We know that one of the important mandates for the RBA is to keep inflation under control," Castex says, "and now inflation is getting a little bit out of control."

So what happens next, are we doomed?

The RBA has lifted the cash rate twice in two months, so action to counter the threat of stagflation is underway.

In the minds of the RBA economists, raising the cash rate will slow things down because everything becomes expensive.

But, Castex says, these are complex levers the RBA is now pulling, and the central bank can only fix so much with rate hikes.

The RBA has to fight inflation by raising the cash rate, he says, but it will come at a cost.

"It will reduce economic growth at levels that we don't yet know what will happen," he says.

What can happen as the cash rate lifts?

Higher mortgage repayments is the first thought, but it runs deeper than that.

More broadly, when there is no growth, companies retreat, producing less and dialing back on new hires.

So raising the cash rate will lower inflation, but people will also want to spend less.

This, Castex says, can cause a sharp slowdown in economic growth, or even a recession.

"There is a trade off there."

READ MORE: One in four Aussies struggling with rising cost of living

And what about that World Bank report?

It flagged some worrying trends.

They now expect the global economy to grow just 2.9 per cent this year, which is down sharply from growth of 5.7 per cent last year.

And it's also notably lower than the World Bank's forecast of 4.1 per cent, made just six months ago in January.

READ MORE: More Aussies getting second jobs to cope with the rising cost of living



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