Australia’s Record Recession Free Run Looks Set to Continue for Some Time Yet

A recession is formally defined as two consecutive quarters of negative GDP growth or negative growth in annual terms.

Australia has not had such an event since the early 1990’s. However there is ample evidence that the economy is weak:

• GDP per capita has contracted over the year.
• Consumer spending per capita has contracted over the year.
• Private domestic demand has contracted over the year.

In terms of how the economy might “feel” to households, in particular, these measures certainly point to a downbeat economic climate.

But this is not a recession with the associated extreme pain for households, businesses, and institutions.

So why has Australia not experienced a technical recession since the early 1990’s?

1. Strong population growth: potential growth is measured as growth in the work force adjusted for productivity growth. Using the global benchmark of 1% for productivity growth, Australia’s potential growth rate is around 2.75% compared to the US of 1.75% and Europe of 1.2%. A high potential growth rate is some protection against a technical recession but, as discussed above, when measured on a per capita basis, Australia has experienced periods of negative growth.
2. At the times of major external shocks – GFC is the best example – Australia’s fiscal position has been in solid shape to accommodate a strong (“go hard; go households”) policy response which is further complemented by the automatic stabilisers (via lower tax and higher welfare payments). Australia’s budget position went from a surplus of 1.7% of GDP in 2007/08 to a deficit of 4.2% of GDP in 2009/10. Australia’s surplus is currently estimated at around 0.5% of GDP in 2019/20 – lower than in 2007/08 but a surplus no less.
3. A flexible exchange rate – in the GFC and in the Asian Financial Crisis (1997/98) the AUD adjusted into the USD 0.50’s to offset the impact of the shock.
4. A flexible labour market also helped during the more recent shocks – employers tended to adjust hours worked rather than staffing levels, cushioning some of the ‘second round’ impacts on household incomes. The more rigid industrial relations systems that prevailed in the 1970s, 1980s and early 1990s made it more difficult to absorb cyclical shocks.
5. Compensating cycles: most recently, when the mining boom turned down the Australian economy was boosted by the state government infrastructure boom and the residential (mainly high rise) construction boom.
6. When it appeared that Australia was headed for two consecutive quarters of GDP contraction in 2008 Q4 and 2009 Q1, domestic demand did contract in those quarters (low point of the GFC) but GDP expanded in 2009 Q1 due to the impact on net exports of China’s massive post GFC stimulus package. With the media speculating on a technical recession, the announcement that Australia had avoided a technical recession saw a spectacular (8%) boost in Consumer Sentiment.
7. Government policy, apart from the fiscal stimulus, also helped Australia avoid a recession in the GFC as banks, whose access to offshore liquidity was under huge pressure, were able to purchase a Commonwealth government guarantee that allowed the rollover of existing short term debt (recall that in that period banks’ wholesale funding was around 60% of total liabilities).

Note that the incidents when Australia came close to but avoided recession in recent times involved flexible markets and significant policy responses to external shocks which were in all cases related to excesses in asset markets – Asian property, dot com bubble, and GFC (housing). Importantly inflation in Australia was low during those periods allowing authorities to complement the fiscal policy response with interest rate cuts.

Australia’s three previous recessions were all characterised by imbalances in the domestic economy which made the economy vulnerable to large global shocks.

In 1974 the world economy was reeling under the weight of the First Oil Shock, and Australia was vulnerable with a fixed exchange rate, little monetary policy flexibility, a huge budget deficit and very high inflation.

The second recession occurred in 1982/83, once again with the world economy under pressure from the second Oil Shock, and the aggressive interest rate policy adopted by Federal Reserve Chairman Volcker to wring inflation out of the system. Australia’s vulnerability stemmed from further pressure on inflation through a major wages break out, boosting inflation above 10%; a fixed exchange rate; and a blow out in the Budget deficit.

The last recession in 1990/91 saw the Australian economy once again vulnerable to global shocks with a world recession coinciding with our own bursting housing and commercial property bubbles (which were partly inflated by pro cyclical rate cuts in response to the share market crash of 1987). The central bank aggressively lifted rates to address the property imbalances and to try to slow the balooning current account deficit. Inflation, at around 7.5%, was still stubbornly high despite the Wages Accord and was a secondary justification for the sharply higher interest rates. The fiscal authorities were slow to recognise the economic emergency. So this recession resulted from the financial excesses of the 1980’s and high inflation triggering policy mistakes both monetary and fiscal.

Where do we stand today?

Note that the three previous recessions were all associated with a global shock. In the 1970’s and 1980’s the shock was an Oil Shock which pressured goods and services inflation. In the late 1980’s/early 1990’s the shock was asset related – first equities and then housing and commercial property.

There were also some regrettable domestic policy mistakes in each of those three recessions: fiscal largesse in 1970’s, fixed exchange rate, and a constrained monetary policy.

In the 1980’s, policy makers allowed a massive wages break out, had a fixed exchange rate, and very high interest rates.

In the late 1980’s interest rates were pushed far too high, fiscal policy was slow to act, and the financial excesses of late 1980’s were encouraged by the banks with the authorities looking on.

(At that time there were no announcements by the RBA of a new interest rate setting so it took far too much time for policy to bite since the market was unaware that the RBA was raising rates).

Today we have learnt a lot and have much more flexible policies to avoid the problems of the past.

• Fiscal policy has considerable scope to act quickly if the recession signals strengthen; there will be a budget surplus in 2019/20 (probably around 0.5% of GDP) and debt to GDP ratio at the Federal level is low. Admittedly, the government is cautious to use fiscal policy at this stage, preferring to await the impact of recent tax cuts and progress towards its Budget surplus (a key election promise). However, were an economic emergency to develop, the fiscal scope is available and the lessons of the past would counsel a decisive response.
• It is true that there is limited further scope for the RBA to provide more policy stimulus but it will not, as was the case in the early 1990’s, exacerbate the issues with a policy mistake. Adopting QE is also capable of bringing down private sector borrowing rates beyond what could be achieved by rate cuts.
• Most importantly, there are no apparent asset imbalances in the economy. House prices have adjusted and appear now to likely appreciate through 2020. Equity markets are not overvalued while commercial property yields are attractive given the very low risk free rates.
• The AUD is flexible. It has already fallen around 40% and will again act as an important “shock absorber” in the event of a sharp “surprise” global shock. Markets assess the AUD as a “risk on” currency so the AUD is likely to adjust sharply in the event of a major global shock.
• As discussed, each of our three previous recessions were associated with a global issue. Global trade is the key candidate today but there is still ample flexibility in East Asia, particularly China – both fiscal and monetary – to provide the necessary stimulus to deal with the impact on those economies of a deteriorating trade situation.
• This is not to deny that the Australian economy will remain weak over the next few years – wages growth is likely to remain weak and growth in consumer spending, if unaided by further fiscal policy stimulus, will remain well below trend.
• There is some optimism in the mining sector – iron ore miners have driven their costs down to around $20 per tonne and are well positioned to absorb any further price falls. Capacity in the LNG sector is booming, supporting strong export volumes over the foreseeable future.
• Large parts of the retail sector are facing near recession conditions (reflecting the cautious consumer, weak wages growth and structural challenges associated with online and changing preferences particularly amongst millennials). With downside risks to wages growth, these conditions are likely to persist for some time.
• Dwelling approvals for high rise construction are down by 60% from their peak in 2016. Recent developments around building quality and cladding are likely to create caution towards unsold dwellings while demand and funding for new developments face major headwinds.
• Strong population growth will continue to support the Australian economy.
• While the global uncertainties are likely to constrain business investment growth, a recession style investment collapse seems unlikely; while state infrastructure investment activity is set to continue to boost growth.

In summary, Australia’s record recession free run looks set to continue for some time yet although prospects of a sustained period of above trend growth seem remote.