Australian Economist Warns Global Economy Will Face Frequent Supply Shocks

A senior Reserve Bank of Australia (RBA) official warned on Wednesday that the global economy will face increasingly frequent supply shocks with broad spillover effects on economic activity and demand. Speaking at the Australian Conference of Economists in Canberra, RBA Chief Economist and Assistant Governor (Economic) Sarah Hunter said large, adverse supply shocks have become more common recently, forcing central banks to continually confront trade-offs in monetary policy settings. Hunter noted that older economic models assumed temporary supply shocks had only a minor impact on overall economic activity. However, a growing body of recent research shows that shocks in specific sectors can create spillover effects on activity and demand across the broader economy. “As we have seen recently, large economic shocks can create uncertainty, reduce confidence, and for some, limit spending on other goods and services. Ultimately, this can weigh on household spending, and lead firms to delay investment decisions and reconsider their hiring plans,” Hunter said. Referring to oil price volatility triggered by Middle East conflicts, Hunter said some types of shocks would pit the RBA’s mandate objectives against each other by pushing up inflation while simultaneously suppressing demand and economic activity, creating a dilemma for monetary policymakers. “The prospect of persistently higher inflation suggests interest rates should be raised. Yet at the same time, weaker economic activity and greater spare capacity suggest interest rates should be lowered,” Hunter said. “This trade-off is unavoidable. Central banks can only decide how to balance the impact on inflation and economic activity, while ensuring that temporary shocks do not become persistent inflation.” In mid-June, the RBA Board decided to hold the benchmark cash rate target at 4.35 percent, following three consecutive 0.25 percentage point increases between February and May. According to the latest data released in June, Australia’s annual headline inflation rate eased from 4.2 percent in April to 4.0 percent in May. However, the annual underlying inflation rate rose from 3.4 percent to 3.6 percent. The RBA Board is next scheduled to meet in mid-August.