A recession may be inevitable


The messages are clear. The Reserve Bank has been much more outspoken recently than usual. It even took the previously unimaginable step of announcing, in the middle of the election campaign, that it had roughly halved its previous growth forecast for this year. It has now had to reluctantly lower the cash rate, with the clear expression of its concern about the state of our economy.

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By visiting the RBA Governor as one of their first post-election steps (stunts), Prime Minister Scott Morrison and Treasurer Josh Frydenberg sought to bathe in the reflected glory of the inevitable rate cut (hang the significance of RBA independence), and then to bully the banks into passing it on. Their hope, and that’s all it is, is that this cut, coupled with their inevitable tax cuts, and the increase in the minimum wage, will sustain a Morrison re-election “miracle” bounce in business and consumer confidence.

The recent growth numbers confirm our precariousness. We’ve had three quarters now of very weak domestic growth, with record levels of household debt, diminished savings, flat wages, still falling house prices, a majority of households struggling with constant increases in their costs of living, many businesses struggling to survive, against the background of a slowing world economy, volatile global financial markets, a US/China trade war, disruptive technology and a host of geo-political tensions.

At best, there are mixed messages from global markets. The bond markets, which it is often ignored are bigger than equity markets, have this year been pointing to a weakening global economy and more cuts in short-tem interest rates – indeed, inverting yield curves, and negative real official rates foreshadowing a recession – yet stockmarkets have shunned this, growth stocks booming at the expense of value stocks.

Prime Minister Scott Morrison and Treasurer Josh Frydenberg meet with RBA governor Philip Lowe four days after the election. Credit:AAP

Central bank balance sheets are still bloated from quantitative easing and debt monetisation. The G7 central banks’ balance sheets are more than three times their size pre-global financial crisis, and they are seriously constrained in reducing them. So, their capacity to respond to another GFC is limited. The fiscal capacity of most major governments to respond to another crisis is also seriously constrained.

The hope that this week’s RBA rate cut will stimulate housing and consumer and business spending is exaggerated. The best hope would be some minor boost to consumer spending. Even if the cut were to be passed on in full by the banks, which as we’ve seen it won’t be, it is negligible compared with the bank-induced credit crunch post the royal commission.

Our bank balance sheets are heavily “sub-prime”, both in housing and fossil fuel exposures, They have a significant exposure to interest-only mortgages, and to many borrowers moving into negative equity and mortgage stress. Business loans have also been seriously constrained.

In succumbing to pressure, both market and political, to lower the cash rate after some three years, the RBA has embarked on a desperate attempt to try to sustain growth and employment that in the end will be a route to negative interest rates through debt monetisation, even printing “helicopter money” and dropping it into the economy, with significant longer-term consequences.

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On the fiscal front, the Morrison government has committed to a series of budget surpluses beginning next year, and to consequent debt reduction. Ambitious, manufactured, forecasts aside, the probability is low that it can deliver, especially as our and global growth slows, with the risk of another GFC and/or of a global recession.

Ironically, try as hard as politicians and bureaucrats inevitably do to avoid the R-word, the ultimate consequence of their short-term responses may indeed be a recession. Moreover, a short, sharp, managed recession may be the most effective mechanism to reset economies, and to initiate the broader-based reform so essential to their longer-term viability.

How long can our government go on pretending that this will all end well? As politically difficult as it has made it, the need for broad-based reform, across most major areas of public policy, has probably never been greater.

John Hewson is a professor at the Crawford School of Public Policy, ANU, and a former Liberal opposition leader.

John Hewson is a professor at the Crawford School of Public Policy, ANU, and a former Liberal opposition leader.

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