Recession is the word that is often associated with economic
downturn, and everyone thinks they know recession, but do they? Sure, there are
certain historical recession that we can all agree on like to the 1920s great
depression, the 1970s/1980s great inflation, the 2000s dot com bubble, the 2008
global financial crisis… and more recently the 2020s COVID-19 supply chain
breakdown. Wait, was that a recession? You see, how can it be black and white,
if each country defines recession differently?
The US defines recession as “a significant decline in
economic activity spread across the economy, lasting more than a few months,
normally visible in real GDP, real income,
employment, industrial
production, and wholesale-retail sales”.
In Australia, UK, and many other parts of the world, recession is when there is
a negative GDP growth for two consecutive quarters. In China, an annual GDP
growth of less than 8% can be considered as a recession.
Call it what you like, the greater question is what is
social impact of a recession, and why do governments want to avoid it? The most
prominent aspect of a recession is excessive unemployment. When unemployment
rate is high, households struggle to make ends meet, thus they cut back on
spending. When household cut back on spending, low-margin businesses struggle
to stay open. Once businesses start to close, it further exacerbates
unemployment rate, and economy falls into a vicious cycle.
At the same time, we must
acknowledge that “recessions” are not limited to contractionary economies.
Inflationary economies can also lead to recession. A growing economy should be
inflationary, however if inflation become too overheated, money loses value. If
prices of good and services significantly increase, consumers and businesses will
see a fall in real income. As living standards drop, consumers demand drops. Businesses
struggle, investments are cut back, jobs are reduced, and the economy rolls
down the path of a contractionary market.
This is why it is important for governments to intervene
with monetary and/or fiscal stimuluses. Monetary stimuluses are
exercised by the central bank with an aim to boost spending power. These
measures often involve adjusting the interest rate and controlling the money
supply in the economy. For instance, in a recessionary economy, the reserve
bank might reduce interest rate and hand out cash, so consumers have more
money to spend. In an inflationary economy, the reserve bank can restrict
spending and incentivise savings.
Fiscal
stimuluses are government spendings and policies that strives to boost
spending. For example, infrastructure spendings and tax cuts, so consumers have
jobs and in turn money to spend. Tax cuts work similarly as it allows
consumers to have more money to spend, but this is money already in the
economy, not newly printed money. Fiscal stimuluses are generally funded by
government bonds. If economy is experiencing high inflation, government can
slow down spending and increase taxes.
So here in April
2022, where is Australia heading? To answer where are we heading, we must
answer where are we now. Currently, we are facing high inflationary times due
to supply shortages and high employment rates, if managed well recession can be
avoided.
Let’s apply what we know:
Tightening of monetary policies:
-
Increase interest rate
Tightening of fiscal policies:
-
Slow down fiscal spending
-
Increase tax
-
Other policies – increase jobs, immigration
Now, let’s examine if they will work?
-
Increase interest rate
Ø
Increasing interest too much will send economy
into recession as proven by history and logic is self-explanatory.
Ø
Reasonable increase should minimise disposable
spending, but what if people are already struggling to pay for the essentials,
like petrol, shelter, and food?
o
How can we help lower-income households without
impacting too much on inflation?
-
Slow down fiscal spending
Ø
Infrastructure and amenities spending on
regional areas to help housing affordability.
o
This could boost inflation further in regional
areas. Will this manage inflation in the cities?
Ø
Increase social housing to help low incomers
-
Increase tax
Ø
Tax cuts for small businesses has already been
announced. This is help businesses survive after the COVID impact and keep up
with the increasing wages. The policy is placed to avoid recession.
o
Will this increase inflation? Or does the befit
outweighs the consequence.
Ø
Individual income tax for low and middle income
earners have also been given up to $1,500 tax offset. This will only come a
maximum of approximately $500 once off payment from tax return.
o
The counter-inflationary effectivity is to be
questioned.
Ø
A reduction of 22 cents/L on petrol for 6 months
to help living cost.
-
Increase jobs
Ø
Both labour and Liberal parties are promising to
increase jobs, it hard to imagine the benefit if unemployment rate is already
below the government ideal. What people was is an increase in real wages.
o
Increasing employment can increase wages, though
the result is either higher inflation or small businesses closing.
-
Immigration
Ø
As much as immigration is dependent on
Australian policies, it is also dependent on the state of the world. Both
labour and liberal are favourable toward skilled labours for immigrants, though
visa numbers remain at pre-COVID levels.
So, it seems that if we want to resolve inflation, only
interest rate and immigration are helping, everything else will not be.
What would I do differently? Increase interest reasonably,
increase immigration, stop creating new jobs, limit tax cuts to low-income
earners and small businesses, create minimum infrastructure additions in
regions.
It is worth noting that all these monetary and fiscal tools
are targeted at consumers or the demand-side. We have no tools for the supply-push
inflation.