Is a global recession looking likely?

Economics is confusing at best. But right now, it’s downright counterintuitive.

Inflation is at its highest point in decades, and we are feeling the pain of lower real wages that comes with it. Meanwhile, unemployment is at its lowest in half a century, and virtually anyone who wants a job can get one.

Interest rates rise sharply. House prices are falling, but rents are rising. The United Kingdom is on the brink of a financial crisis. There is talk of a global recession everywhere.

Even if you don’t mind what’s happening (maybe it doesn’t bother you much or maybe it benefits you in some way), you’ll probably have a hard time getting the hang of it all. Our policy makers certainly are.

It started with the pandemic
The first thing to understand about what is happening is that it cannot be separated from the pandemic.

Two years ago, at the start of the pandemic, Australia went into recession for the first time in 30 years.

And what an unusual recession it was. It was sharp, but rather than the collapse of a speculative bubble or a downturn in the business cycle, it followed years of perfectly sustainable, albeit weak, economic performance.

It is worth recalling a few things. Australia has handled the public health side of the pandemic better than most. That meant that, while sharp, the collapse in economic activity was less severe than policymakers had expected.

While generally still in service, Australians were much less able to spend. International travel, eating out and going out had to be suspended.

At the same time, Australia launched one of the largest fiscal and monetary support programs in the world. Interest rates were set to zero and the Reserve Bank used unconventional tools to flood the financial markets with money.

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JobKeeper and the cash flow boost for businesses, along with the JobSeeker Allowance (and eased eligibility), money transfers for government benefit recipients and A$38 billion in pension withdrawals created the largest fiscal stimulus in Australian history.

Support that could not be spent
Households and businesses were flooded with cash during the pandemic, but with not many places to spend it. Many of those expenses were simply postponed.

Without the benefit of hindsight, this should not be considered a mistake. As Australia’s foremost monetary economist, Professor Bruce Preston of the University of Melbourne, put it, we have taken cautious insurance.

It had been 100 years since the last pandemic of this magnitude, and it was impossible to say how bad it would get. It was safer to do too much than too little.

But just as insurance involves a premium, so too do too many incentives. Once the economy reopened, too much money chasing too few goods and services would only end in one way: higher prices.

This was compounded by supply chain constraints, some simply the result of the global economy turning on and off and others the effect of the Russian invasion of Ukraine on global commodity prices.

Then the floodgates opened
The problem with high inflation is that we can’t count on it to resolve itself. It is true that higher prices lower real wages, stifle spending and help push prices down. But it is also true that they can fuel higher inflation expectations, which does the opposite.

If people expect high inflation, they are more likely to bring forward purchases simply because they expect prices to rise. And workers demand higher wages, and companies higher prices, in anticipation of the higher prices they will face in the future.

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In this way, inflation can be self-reinforcing and thus more difficult to stop. That is why monetary (interest) and fiscal (government taxes and spending) policies around the world have been quickly tightened – to ensure that a temporary period of high inflation does not become entrenched.

It seems that this has already happened in the United States, the United Kingdom and Europe. It is not yet clear whether it will happen in Australia.

The loose monetary policy around the world up to the 1970s offers a lesson for what not to do in a situation like this. It took ten years, well into the 1980s, to bring inflation under control.

Nothing is worse for real wages and living standards than high inflation. Ask those who live in Argentina and Turkey where purchasing power is falling.

Ideally, policymakers would have seen inflationary pressures build up and tightened institutions sooner and more gradually. The later the response, the sharper it must be – and the more damaging the economic consequences.

The Australian Reserve Bank lagged sluggishly, months behind the Reserve Bank of New Zealand and a month behind the US Federal Reserve. It’s hard not to see that as complacent. And the Australian federal government continued to accelerate long after the bank began to brake – with huge additional incentives deployed irresponsibly by both sides of politics in May’s election.

And we haven’t seen any action from our new government against inflation. It’s hard to say what it’s waiting for – maybe next week’s budget.

His messages don’t help. The treasurer’s constant references to a ‘dangerous’ global economy is irresponsible at a time of fragility – he must remember that he is now the treasurer – his words can have a real effect on the results.

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And the Reserve Bank’s traditionally poor communication hasn’t gotten any better. It flipped at this month’s board meeting and halved the rate of increase in interest rates, but failed to explain the reasoning clearly in the accompanying statement.

Recession or not, it’s going to be a few bad years
The word “recession” is useless binary. Economists don’t even agree on its definition. In an unusual situation such as a pandemic or post-pandemic, its meaning is even emptier.

What we do know is that global economic growth, including growth in Australia, will be much slower over the next two years than we expected a few months ago.

We have overestimated the ability of the global economy to recover smoothly from the pandemic. And we did not foresee the Russian invasion of Ukraine.

Australia can be expected to outperform most countries. It is less exposed to energy price shocks than Europe and the UK, and as a major energy exporter benefits to some extent from high prices.

But there is a lot of uncertainty about China, Australia’s largest export customer. A sharp downturn there, caused by something like a real estate collapse, would pose a serious risk to the Australian economy.

It is important to note that the problems we face are likely to be temporary.

While no one has a crystal ball, it seems reasonable to expect a return to something normal, resuming our old pace of economic growth in a few years.

Before you know it, we’ll be engulfed again by debates about how to reinvigorate weak growth, weak wage growth and weak productivity growth – our economic preoccupations before the pandemic hit.

Originally published by The Conversation
Author: Steven Hamilton – Visiting Fellow, Tax and Transfer Policy Institute, Crawford School of Public Policy, Australian National University


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