Australian Economy

A recession is not inevitable in Australia – and certainly not necessary | Greg Jericho

Unemployment is lower than it has been for nearly 50 years and yet the most common question I am asked is if we are going to have a recession.

The question is not without cause, and the response – as is often the case – is best addressed by the sage words of Reverend Lovejoy: “Short answer, yes with an if; long answer, no with a but.”

Here in Australia, more people are searching “recession” on Google than any time in the decade between the GFC and the pandemic, while the latest Morgan-NAB consumer confidence rating has consumers as wary as they were in April 2020 – you know, when it seemed like the world was about to end.

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What is going on? Have we all been listening to the Smiths and Joy Division records nonstop?

The problem is the disconnect with the current economic situation and fears for the future.

Currently unemployment is below 4% and underemployment is below 5.7%. Whatever you think about those measures, they are at decidedly non-recession levels.

Similarly, the current level of hours worked per capita is well above the pre-pandemic levels (albeit remaining pretty erratic).

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The Department of Employment’s leading employment indicator remains in positive territory (suggesting growing employment), even if it has come off the boil a bit from last year.

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So the labour market is showing no signs of a coming recession. What then is the issue?

Inflation growth, or more to the point, what might be done to stop it from increasing.

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Inflation is now growing faster than it has in 20 years and soon is expected to be as fast as it has been since the 1980s.

And the common “cure” for rising inflation is higher interest rates (as we have already experienced).

One problem is if, as happened in the 1980s, rates go up so fast that the economy slows to a stop.

The other problem is Australian interest rates have no impact on the world price of things such as oil, gas and wheat and thus all that might occur is we get a slowing economy, but with inflation continuing to grow well above 3%.

Hello stagflation!

It is thus not surprising people are feeling a bit antsy, especially as some economists and policymakers are sounding very scary about what needs to be done to reduce inflation.

In the United States, for example, former treasury secretary Larry Summers recently said that “in order to do what’s necessary to stop inflation” interest rates would need to raise by enough “that the economy will slip into recession”.

Such talk is very foolish and can become a bit self-fulfilling if consumers and business begin to act as though a recession is coming.

The level of inflation we have in Australia and its causes do not require a recession to reduce them. Any such thinking should be treated with the same contempt as the belief that wages are about to rise at levels seen in the 1970s when pattern bargaining was a thing.

But leaving that to one side, the reality is most times the Reserve Bank has raised the cash rate, rises in unemployment (if not recessions) have followed.

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The difficulty is that economic policy is pretty imprecise and there is a non-zero risk that the RBA will get it wrong and increase rates too fast.

This risk is heightened when you consider real wages have fallen over the past year, meaning any buffer from higher rates will have to come from the build-up of savings that occurred during the pandemic (because we were limited by things we could do).

Nationally there are large levels of increased savings, but such wealth is rather less equally shared than is income, and this makes it tricky to avoid having large sections of the society hurting a lot more than others from rising rates (and in turn rising rents).

Right now I believe the market is predicting the RBA will raise the cash rate too fast.

The market anticipates the cash rate will hit 3.5% in March next year – a massive increase, if well down on the absurd predictions a month ago of a 4.25% peak.

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This would see the Reserve Bank hit the economic brakes harder than it has since the late 1980s and see rates rise in nine months by as much as they did in 71 months during the mining boom.

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Repayments on a $600,000 home loan would rise by around $1,060 a month (a 42% jump), with the average discounted mortgage rate rising to 6.8%.

Would that trigger a recession?

My guess is yes … if.

However, I don’t think it will happen.

I am more aligned with the NAB’s prediction that the cash rate will hit a high of 2.6%.

Those sitting around the Reserve Bank board know what happened in the 1980s and 1990s. I suspect that is why the past two months have seen successive 50 basis point increases instead of the usual 25 basis points.

It’s been a bit of shock treatment to let people know they are serious and hopefully prevent more rises later on.

The problem however is that while Australia is an island, it is not “entire of itself”. Things around the world affect our economy – especially if the US, which is battling higher inflation than us, does go into a recession.

One recession indicator is when the yield (or interest rate) of long- or medium-term government bonds is lower than short-term ones.

And right now the yield on US five-year Treasury bonds is lower than for two-year bonds.

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That is not the case in Australia, but over the past 25 years, whenever this has occurred in the US, it has also occurred in Australia soon after.

And after that, economic stagnation has followed.

No, a recession is not inevitable and certainly not necessary, but the risks are there.

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