The Australian economy is entering its 24th year without a recession, as we move into the second half of 2014.
This is a feat of extraordinary economic management and terrific good luck. Most economies experience a recession every seven to 10 years or so, as Australia did prior to the 1991 slump. The reasons why Australia has managed to avoid a period of falling GDP and sharply rising unemployment over recent decades fills one with optimism that the next recession is still some way off. Policy makers have been, and still should be, shrewd and pragmatic, pulling the policy levers without fear or favour as growth and jobs dominate their objectives. Hugely important for Australia’s recent success has been the conduct of monetary policy, including the free-floating Australian dollar. The Reserve Bank of Australia was quick to cut interest rates when recession threatened Australia as the Asian crisis hit in the late 1990s; the tech wreck smashed the US economy in 2000 and the 2008-2009 global banking and financial crisis saw the world economy slump to its weakest since the Great Depression. The Reserve Bank did so knowing that the downside growth risks would see inflation remain within its target. Indeed, as each of those threats to the Australian economy loomed, the RBA sliced rates to what were record lows. The floating Australian dollar did its bit to support economic growth and jobs as it fell at least 20 percent each time recession threatened. The benefits to the economy are obvious. Exporters not only get an income boost from the lower currency, but the competitive position of local import competing firms is enhanced as import prices rise. The lower Australian dollar also makes it more attractive for foreign investors to invest in Australia, which provides a valuable source of capital for the economy. The other element of economic management is fiscal policy. With trivial levels of government debt over the past four decades, the Howard Government responded to the US recession with an easier fiscal policy, which saw real growth in government spending rise a thumping 9.1 per cent in 2000-01, and the budget slip into deficit in 2001-02. This was appropriate given the downside risks coming from the US slump. The Rudd Government, which obviously confronted a much more parlous economic climate in 2008, aggressively eased fiscal policy with a deliberate strategy of temporary fiscal measures, which centred on cash handouts, a fast track for school infrastructure and insulation for one million houses. These policies promoted economic growth and saw the economy avoid the worst aspects of recession as the budget deficit delivered a near textbook approach to smoothing the business cycle. Then, of course, there was good luck. China emerging as Australia’s major trading partner was the first bout of good fortune. This generated a huge and sustained lift in demand for Australian exports. Booming export volumes supported bottom line GDP growth, which in turn prompted a stunning lift in mining investment. A lift in export prices for many of the commodities Australia exported was another fortunate bout. Not only was the volume of exports booming, but the prices exporters received reached record highs, which helped to maintain national income during the slump in activity from the global economy. The near quarter-century duration of the current economic expansion means Australia is overdue a recession. But what will cause it? When Australia falls into its next recession it will be driven by either an external global shock or a domestic policy error that is not recognised early and is allowed to fester. For the near term, the global outlook looks solid. While a Chinese slowdown or a property burst or a banking crisis remain risks, forecasts of the demise of the Chinese economic miracle have failed miserably over the last couple of decades. A stronger US economy and even a few hints of a turn in the Eurozone, Japan and India bode well for Australia, even though risks remain. Domestically, the recession risk seems to be focused on housing and a collapse in house prices from the current high levels. The question is whether there has been already been an error which has allowed house prices to rise so much with very low interest rates and easy regulatory conditions for borrowers and lenders. That said, if house prices were to fall rapidly, the RBA would be alert to the growth and deflationary consequences and would surely cut interest rates to head off the risk of a recession. Unlike many countries around the world with zero interest rates and therefore little scope to cut, the current cash rate in Australia, at 2.5 per cent, could easily be sliced to stabilise growth. In this scenario, there would seem little doubt the Australian dollar would lower sharply and thus provide that boost to the economy seen in other episodes of recession risk. Given the huge success of fiscal policy during the 2008 crisis, Treasury would no doubt been keen to follow a very similar path of fiscal stimulus if it appears that growth was faltering and a recession was on the horizon. Australia will fall into a recession one day, that is for sure, but in the near term, the risks of such a fate seem low. The lessons from the past two decades are so striking that the blue print for avoiding recession is in place. Of course, it is possible that today’s policy makers do not heed those lessons and choose a different option, such as aiming for a budget surplus or holding off interest rate cuts for fear of having the cash rate approach zero. As mentioned, that seems improbable and more likely Australia will clock up a 24th year without recession. Stephen Koukoulas is Managing Director of Market Economics thekouk.com