New stimulus drives strong recovery

While gross domestic product (GDP) fell a record 7 per cent in the June quarter, the result would have been far worse without fiscal support amounting to close to 15 per cent of GDP in the quarter. Fiscal support, complemented with other measures like loan payment deferrals for both mortgages and business loans and temporary protection from insolvency, has so far prevented some of the worst of the second round impacts normally apparent in deep economic downturns.

"In ANZ Research’s view it will take until the September quarter 2022 to claw back the losses from H1 2020 and bring GDP back to its pre-pandemic level.”

But it is not clear how long this will continue to be the case. The extended lockdown in Victoria has severely hit Q3 growth and much of the fiscal support is scheduled to end in Q4.

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ANZ Research expects GDP to have expanded at a modest pace in the September quarter with the opening up of businesses and easing of restrictions outside Melbourne more than offsetting another fall in activity in Victoria. Performance across the states has diverged sharply over the quarter with Western Australia picking up sharply while New South Wales looks to be languishing alongside its south-eastern neighbour. These divergences aside, business conditions have picked up solidly in every state from the average in Q2.

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Household spending has also improved from its April low point although the initial surge has now largely faded. ANZ spending data show spending accelerated out of the lockdown, through June and July, supported by a second round of household stimulus payments in early July. Since then spending growth has slowed across the country, most markedly in Victoria where spending has been below year-ago levels since mid-July and in New South Wales where growth has been flat-lining since early August.

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These spending numbers have been boosted by the very large fiscal stimulus directed towards households. With support payments set to be reduced sharply from the end of September, however, the outlook for household spending is particularly uncertain. On the current timetable, there is set to be a reduction in fiscal stimulus in the order of 10 per cent of GDP in Q4.

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ANZ Research’s view, however, is this premature withdrawal of stimulus will not eventuate. In the 2020-21 Commonwealth Budget, due to be handed down on 6 October, ANZ Research expects further announcements of large scale fiscal stimulus. This spending will be aimed at supporting incomes in the short term and driving jobs growth in the medium term. Moreover, ANZ Research expects state governments to announce large support packages of their own.

With fiscal policy now the key policy instrument for demand management, ANZ Research feels compelled to incorporate the view of the likely trajectory for policy into forecasts. But there is clearly a large band of uncertainty around the size and shape of prospective fiscal stimulus. Different measures will have different multipliers and varying impacts. A larger/smaller magnitude of stimulus would have upside/downside risks for forecasts while the same is true of support measures with higher or lower fiscal multipliers.

ANZ Research’s assumption of large scale fiscal stimulus underpins the outlook for a solid recovery in 2021. After a modest improvement in the second half of 2020, ANZ Research now expects growth to bounce back solidly through 2021 and forecast growth of 5.0 per cent through the year. While this would be a very strong result – the strongest since the late 1990s – it would still leave GDP 1.7 per cent below pre-pandemic levels. In ANZ Research’s view it will take until the September quarter 2022 to claw back the losses from the first half of 2020 and bring GDP back to its pre-pandemic level.

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Public spending will be the major driver of growth in 2021. With ‘shovel-ready’ infrastructure likely to start as quickly as possible, as well as other ‘nation-building’ projects, public investment is likely to rise quite strongly. Along with a solid increase in public consumption, ANZ Research expects public demand will rise above 30 per cent of GDP for the first time since the mid-1980s.

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In contrast, private sector spending is likely to remain under pressure over the next year. Household consumption will be weighed down by the winding back of government payments to households (as the JobKeeper and JobSeeker levels fall), a weak labour market and ongoing caution about both the health and economic outlook. Similarly, businesses will remain unwilling to invest and hire until the path for the economy looks clearer.

Supportive policy to remain

There are clearly crucial differences between the current recession and those of the early 1980s and 1990s. The current one was caused by the response to a health crisis rather than higher interest rates flowing from an economy that was overheating. The policy response has been faster and much larger than even that which followed the Global Financial Crisis (GFC). The monetary policy response has, however, been more moderate. This reflects the starting point of already very low interest rates rather than any sense of complacency by the Reserve Bank of Australia (RBA).

These differences mean ANZ Research needs to be cautious about drawing too many lessons from past events. Even so, ANZ Research believes one of the takeaways from the last two recessions and the GFC – that it takes many years for the labour market to recover – will apply this time too.

With that in mind, ANZ Research thinks it imperative that policy remains stimulatory for an extended period. If ANZ Research’s outlook proves to be too cautious then this will be a good problem to have, with policy able to tightened if activity recovers faster than expected. ANZ Research sees little risk of such an approach causing a lasting breakout of inflation that will take years to contain.

When thinking about the economic and social costs of high unemployment, ANZ Research thinks the bigger mistake would be to withdraw stimulus too early. Certainly ANZ Research doesn’t think there is any need to do so over concern about an approaching constraint on government debt.

In this environment, ANZ Research expects there will be much lobbying for government support. It is vital, however, that appeals for more government spending (or regulatory intervention, for that matter) continue to be subject to rigorous analysis to ensure that the government gets the best bang for its buck, maximises the fiscal multiplier and the long-term prospects for Australia.

Fiscal settings will be critical in determining the timing and extent of any further policy steps by the RBA. The RBA’s approach is to take existing fiscal settings for its forecasts rather than try to build in possible changes. This is understandable. Having the RBA include possible changes in fiscal policy in its forecasts could be interpreted as an attempt to intrude directly into the policy development process. It does mean, however, that when fiscal settings change materially, the RBA’s forecasts can become out of step with what is happening.

If ANZ Research is close to being right on the size and scope of fiscal developments in the coming federal and state budgets, then this fate will befall the RBA’s August forecast update. At the very least, the RBA will want to incorporate as much of the new fiscal settings into its forecasts before it considers taking any further policy steps itself. This makes a policy change in October very unlikely, in ANZ Research’s view.

What’s more, ANZ Research thinks the fiscal measures will be large enough to push the RBA to the sidelines for some time. The thinking at this stage is that the RBA won’t seriously consider further moves until May 2021.

It won’t just be fiscal policy that matters for the RBA, to be fair. The data will also be critical. In particular, developments in the labour market. Much weaker than expected employment data could see the RBA reaching into its (limited) policy tool box earlier than this. Global developments will also matter, not least what other central banks are doing.

But the RBA expectations for employment over the rest of this year are already quite negative. In the August Statement on Monetary Policy, the RBA forecast by the end of the year the unemployment rate would hit 10 per cent and employment would have contracted by 6 per cent year-on-year. This implies it expects substantial employment losses over the second half of 2020, such that employment could approach the low point recorded in May when most of the country was still under tight restrictions.

This reduces the prospect of the RBA being surprised to the downside, which reinforces ANZ Research’s view Australia is in for a period of stability on the monetary policy front – assuming, critically, the judgement ANZ Research is making about fiscal settings is broadly right.

Felicity Emmett is Senior Economist and David Plank is Head of Australian Economics at ANZ