In Small World: Underground, do the Iron Dwarves keep their hammers from turn to turn?
Yes

You are playing this correctly.  Perusing the rules and the BGG forums (where the designer posts occasionally) there isn't any doubt that the hammers accumulate to their maximum of 7 every turn.

It is also noted that the races and particularly race/power combinations are not meant to be balanced in Small World: Underground.  Players should be expected to have to overpay when powerful combos show up and to be teamed up on in 3+ player games when they do get the powerful combo.