Frontier thinks Government policy will lessen damage

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Frontier Advisors last month published its initial views on the dramatic shift in the global macro-economic environment which suggested the Australian economy could contract by 6 per cent in 2020 due to Covid-19. The firm will today publish a follow-up short paper for clients, which shows some optimism given the fiscal response of Australia’s federal and state governments. But we’re headed for a recession, nonetheless.

The follow-up report focuses on the important role of policy in dictating how this will ultimately play out from an economic point of view. A spokesperson said: “Under the modelling framework we have been using, given the size of the policy response being announced, the economic slowdown from Covid-19 could be significantly lessened and an economic recovery occur sooner… However, while the policy response will help significantly, Australia is still likely to experience a painful recession with significant job losses in the short-term.”

Frontier expects to produce a third paper for clients – making it a trilogy, or mini-series – which will focus on the serious implications for what is happening in the Australian labour market. Newspaper images of long lines outside understaffed Centrelink offices reminds one of historical photos from the Great Depression.

The latest Frontier paper says that based on announcements from some of the key global economies, the size of the current planned fiscal expansions is comparable to other times in history which resulted in large fiscal deficits. Specifically, it says:

  • “For China, separating monetary and fiscal policy is somewhat challenging, and the fiscal expansion estimate may understate the policies China has been putting in place. Nevertheless, we expect that China could still announce further large stimulus measures, and
  • The current planned fiscal expansion in Australia will likely be of unprecedented levels, at around 16 per cent of GDP. However, this takes into account a sizable amount of loan and guarantees provided by the RBA which would not directly impact budget balance.”
  • Given the aggressive stimulus package announced, the budget surplus previously projected will no longer occur. We estimate that the fiscal deficit could rise to nearly 8 per cent of GDP, if expenditure rises in line with current announcements and if revenues fall in a similar manner as occurred in the global financial crisis (GFC). The fiscal deficit could be larger if the government implements additional stimulus, and if revenues drop a lot more than in the GFC, when Australia technically did not experience a recession, benefiting from a China-led commodity price boom.

A fiscal deficit of about 8 per cent of GDP, although unprecedented in recent times in Australia, is comparable with the fiscal response being deployed in other countries in response to COVID-19 or further back in history. For example, the US ran a huge fiscal deficit (at 26 per cent of GDP) during WWII, and Japan recorded a deficit of 10 per cent of GDP during the GFC. The paper suggests that inflation will probably rise a bit, but still remain within the RBA’s target range. It says: “Enormous cash injections along with the currency depreciation could pose a potential inflation risk to the Australian economy. Given high household debt levels, the RBA cash rate is expected to stay at low levels for a prolonged period. This implies that monetary policy might not respond quickly to a pick-up in inflation.

“However, the GFC’s history showed that huge stimulus measures did not necessarily trigger a surge in consumer prices. Market measures of inflation expectation have increased in response to the announcement of monetary and fiscal stimulus but are still at a level far below the inflation target.”

– G.B.

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