UBS HSC Online Economics Day, Tuesday, July 21, 2020
Australia is in the grip of a recession that’s its deepest since the Great Depression of the 1930, but also it’s most unusual, being the consequence not of problems in the economy, but of the effects of the coronavirus pandemic and the government’s response to it. After the government realised the virus had spread to Australia, it banned foreign arrivals from China at the start of February and progressively widened the ban to include all foreign nationals, with all returning Australians required to enter 14-day quarantine. In concert with the state governments, it then moved to limit the spread of the virus within Australia by ordering many industries, schools and universities to close. It required people to work from home where possible, and leave their homes as little as possible. During this “lockdown”, hand-washing and “social distancing” were encouraged, and large gatherings and unnecessary travel were banned.
This hugely reduced economic activity, prompting many businesses with little revenue coming in to lay off workers or reduce the hours of part-time workers. So from mid-March, the government introduced a series of measures intended to assist firms facing financial pressures, helping them retain their staff until the crisis had passed, to help people who had lost their jobs, maintain the training of apprentices and trainees, help firms and households having difficulty paying their rent, and assist industries with particular problems, such as housing and airlines. Taken together, these measures would provide fiscal (budgetary) support to the economy in general, at a time when private sector demand was weak. All these measures were designed to be targeted to easing particular problems and to be temporary, running for about six months to the end of September 2020.
The government’s two most important measures were the $70-billion JobKeeper wage subsidy scheme, which paid those employers whose revenue had fallen significantly subsidies of $1500 per fortnight for each worker they retained. This unprecedented and hugely generous scheme – adapted from similar schemes introduced in Britain and the US – was intended to maintain the link between an employer and its workers until the crisis had passed and normal business could resume. For those workers unable to benefit from the JobKeeper scheme, the JobSeeker coronavirus supplement effectively doubled unemployment benefits by adding a supplement of $1100 a fortnight for six months.
In mid-March the Reserve Bank made the last contribution it was able to make toward stimulating demand. First, it cut the official cash rate by 0.25 percentage points to its effective lower bound of 0.25 per cent, and promised the rate would not be raised until the rate of unemployment was falling towards its full employment level (about 4.5 per cent) and the inflation rate was in the target band of 2 to 3 per cent. It made a move to “quantitative easing” by setting at target of 0.25 per cent for the yield on Australian government bonds. That is, it promised to buy as many second-hand bonds as was necessary to get the yield down to 0.25 per cent. So far, this has involved it creating credit (or “printing money”) only to the extent of about $50 billion. Third, to encourage the banks to ease their repayment requirements on hard-pressed small businesses, the RBA offered to lend them up to $90 billion at the concessional rate of 0.25 per cent. This too would involve the RBA creating credit. So far, however, there has been little demand for this relief.
The crisis caused the annual federal budget to be postponed from May until Tuesday, October 6 (just a few weeks before the HSC Economics paper on Friday, October 23). In the meantime, however, Treasurer Josh Frydenberg will deliver an economic statement this Thursday, July 23, in which he will announce changes to the JobKeeper and JobSeeker schemes after they are due to expire at the end of September. He will also announce new forecasts for the economy and the budget deficit.
Definition of recession
Don’t be misled by media assertions that the economy is in recession when real GDP falls in two successive quarters. This mere rule of thumb has no status in economics and can be misleading. It puts all the emphasis on production and none on the real reason people fear recessions: rapidly rising unemployment. A former senior Treasury official has defined recession as: “a sustained period of either weak growth or falling real GDP, accompanied by a significant rise in the unemployment rate.” In February 2020, before the virus struck, the unemployment rate was 5.1. By June, just four months later, it had leapt to 7.4 per cent. Over the same period, the rate of under-employment jumped from 8.7 per cent to 11.7 per cent. That’s all you need to know to be certain we’re in a deep recession. But the effect of the lockdown and the JobKeeper subsidy (which involves many people being counted as employed although they are doing no work) means the “effective” rate of unemployment is about 13 per cent [graph 2].
How this recession differs from past recessions
This recession is different partly because it’s much worse than the previous recessions in the mid-1970s, early 1980s and early 1990s – which was almost 30 years ago. Whereas in the early ‘80s unemployment peaked at 10 per cent, and in the early ‘90s at 11 per cent, this time we are already up to 13 per cent and counting [graph1]. The contraction in GDP is also likely to be a lot bigger this time than in those earlier episodes.
But this recession is different – even unique - because its cause is non-economic. To stop the spread of the virus, the government ordered a large part of the economy to cease trading. And even if it hadn’t, many people would have cut their economic activity and kept to their homes to protect themselves from the virus. Normally, recessions occur because a boom has got out of hand and has prompted the authorities to push interest rates too high in an effort to control inflation. They often end up overdoing it and accidentally causing a downturn.
The unique cause of this recession means that, whereas previously the brunt of the downturn has been borne by workers in manufacturing and construction, this time it’s workers in the services sector. The hardest hit have been in accommodation, restaurants and cafes; retail; and arts and recreation. This change in the industrial composition of the recession means that whereas it’s usually men who bear the brunt, this time it’s women. It’s always the young – particularly education-leavers - who are hit hardest by a recession and, I’m sorry to tell you, this time is no exception.
The budget, debt and deficit
All recessions involve the government using the two main instruments of macroeconomic management to cushion the economy from the contraction in private sector demand and, more positively, stimulate an expansion in private demand, by cutting interest rates, increasing government spending, or cutting taxes. This time, however, monetary policy has pretty much done its dash and all the work falls to fiscal policy – the budget.
Whereas the government had managed finally to return the budget to balance in 2018-19 and was proudly looking forward to a surplus in the financial year just ended and many further surpluses in the years ahead, all that has been turned on its head by the response to the virus. The mini-budget on July 23 will give us the latest official figures, but unofficial estimates from Dr Shane Oliver suggest a deficit of about $95 billion (or almost 5 per cent of GDP) in the financial year to June this year, rising to a deficit of more than $220 billion (or 11 per cent of GDP) in 2020-21. Note that this likely enormous blowout in the budget deficit is explained not just by increased stimulus spending, but also by the effect of the recession in causing tax collections to fall. The stimulus is an increase in the “structural” component of the deficit, whereas the fall in tax collections is an increase in the “cyclical” component. In Oliver’s estimates, the two effects are of roughly equal size.
How the budget deficit will be funded
There are various ways the budget deficit could be funded but, at least since the early 1980s, it has always been funded by the government borrowing from the public rather than from the RBA (which would constitute printing money). The bonds are sold by regular auctions conducted by a branch of the Treasury. There is never any shortage of banks, superannuation funds, other fund managers and other countries’ central banks wanting to buy the bonds. This can be seen in the government’s ability in recent months to sell 10-year bonds paying an effective interest rate of less than 1 per cent. It is true, however, that when the RBA buys second-hand government bonds previously sold to financial institutions by Treasury, and pays for those bonds merely by crediting those institutions’ bank account with the RBA, it is doing the modern equivalent of printing money.
