V follows U in the alphabet but in economic terms there is a world of difference – to businesses, to the unemployed, to the state of the budget and to how a government that has spent a decade bashing Labor over its management of the global financial crisis faces its own test.
In the past fortnight, as the true extent of the spread of the virus has become clear, the government has been forced into a substantial change in language.
The starting problem is last year’s election, and particularly the April budget in which Treasurer Josh Frydenberg confidently declared the nation’s finances were “back in the black and Australia is back on track”.
By December, ahead of the summer’s fires and well before Chinese authorities first detected COVID-19, the expected surpluses had been trimmed by tens of billions of dollars. Still, the language about the budget and broader economic management was unchanged. Coffee mugs emblazoned with “back in black” were still on sale via the Liberal Party’s website.
When Frydenberg returned from a meeting of finance ministers and treasurers from the world’s 20 largest economies, held in Saudi Arabia on the weekend of February 22-23, there was still no panic. This was three weeks after Australia had shut the door to non-citizens travelling from China into Australia.
Pressed on whether the economy would need some substantial assistance to deal with the financial fallout from the virus outbreak, Morrison was clear. “I can say, though, in terms of broader larger fiscal stimulus-type responses, that is not the advice we’re receiving from Treasury. In fact, quite the opposite,” he said on February 27.
Just hours after he made that statement, Saudi Arabia banned millions of Muslim pilgrims from entering the country for the Umrah pilgrimage to Mecca. In the following days, the scope of the eruption of cases in Italy and South Korea became known. US President Donald Trump appointed US Vice-President Mike Pence as his country’s coronavirus “tsar”.
When Morrison made the comment, markets put the chance of the Reserve Bank cutting interest rates to a record low of 0.5 per cent at less than one-in-10. Not only did the RBA cut rates at its March 3 meeting, markets now believe the RBA will drop rates to 0.25 per cent next month. That’s the point the central bank itself says it would consider exotic economic measures, such as the purchase of government debt.
This week, Treasury secretary Steven Kennedy told a Senate committee the virus would strip at least 0.5 percentage points from growth in the March quarter. Combined with an expected 0.2-percentage-point hit from the summer’s fires, there is no one in the government who believes the country will escape a quarter of negative growth at the start of 2020.
Frydenberg says the assistance package will be worth “billions”, with a variety of components: “We are focusing on ensuring that businesses stay in business and Australians stay in jobs and that the cashflow will be maintained for many cash‑strapped businesses.”
The government has given clear signs of what the package is likely to look like. An investment allowance for businesses (similar to what the Rudd-Swan government did in the second of its GFC packages) will be a key element, while wage subsidies are also on the table.
Some infrastructure spending, such as grants direct to local councils that always have a shortlist of roads or footpaths that need repair, will also feature. Again, this was a part of the Rudd-Swan playbook.
Self-funded retirees, hit by further falls in interest rates (and the sharp drop in the sharemarket), will get some financial relief via a change to deeming rates.
Morrison and the rest of the government are talking about a package that is a “targeted, modest and scalable”. The aim is to “keep business in business”, ensuring they keep people in work.
Talk, however, about that promised budget surplus has disappeared.
A contraction in the economy of the size Treasury is expecting would put any budget under pressure. There have been three negative quarters of growth since 2000 – all three have been associated with budget deficits. That’s not a surprise. As Kennedy explained, one of the first impacts from an economic shock is a drop in business profits. That immediately reduces company tax collections.
A slowing economy is also associated with an increase in unemployment (which means a drop in personal income tax). Then there is a lift in payments, such as unemployment support.
Deutsche Bank senior economist Phil O’Donoghue, who believes the promised $5 billion surplus will become a $25 billion deficit, puts it simply: “The economy wants a budget deficit. The government should let it have one.”
Both the Prime Minister and Treasurer have made clear their focus is on the economy rather than the budget bottom line. The pair have, rightly, said no one could have predicted the advent of COVID-19 in the wake of a summer of fire. They believe voters will understand the reason for not delivering a budget surplus.
The bigger problem might be what happens beyond the March quarter. If the economy continues to shrink through the June quarter then the Morrison government will have overseen the nation’s first recession since 1991.
Such a declaration – which wouldn’t be made until September 2, when the June quarter national accounts are released – would have a huge impact on consumer confidence. It would also be a blow to the government’s claims to be a superior economic manager to Labor.
One of the key reasons for the Rudd-Swan stimulus package was to avoid a recession out of fear it would lead to a downward spiral in consumer confidence that would flow through the economy.
Ultimately, even the federal Treasury believed Australia would not avoid the global financial crisis. The 2009-10 budget is the only budget to actually forecast a recession, tipping the economy to shrink by 0.5 per cent. Unemployment was expected to average 8.25 per cent.
It didn’t come to pass. Aided by a global stimulus (led by China), the government’s own spending and 4.25 percentage points worth of cuts in official interest rates, the economy grew by 2 per cent and unemployment peaked at 5.9 per cent.
This time round, the RBA has just one more interest rate cut before it enters the world of quantitative easing. As Treasury and the Morrison government have noted, the coronavirus outbreak is having a different effect on the economy than the global financial crisis, which means the fiscal response must be different.
Whatever the response, the government is under pressure to move quickly, especially if it is going to deliver a major boost to the June quarter.
Citi chief economist Joshua Williamson said the longer the virus remains an issue, the greater the economic risk. “The risk is that COVID-19 impact lingers, imparting a longer demand impact to the economy. Rising uncertainty will also delay business investment,” he said. “Such a situation could lead to job losses, which are not limited to tourism or export-related industries.
“If the broader economy is impacted more severely than currently assumed, then the government could be forced to rethink its fiscal strategy in May, that is, abandon hopes of a near-term budget surplus and bring forward other stimulatory measures.”
A V-shaped hit to the economy now seems unlikely. A U-shaped is the government’s best bet. If it becomes L-shaped, the entire global economy will be in trouble.
Shane is a senior economics correspondent for The Age and The Sydney Morning Herald.