Australia’s economic outlook is weak and subject to pandemic-related exogenous factors. The sources of production have excess capacity, and international and state borders are closed indefinitely.
With the Reserve Bank of Australia’s policy options running low, discretionary fiscal policy is necessary to raise aggregate demand and boost employment. Further monetary expansion is likely, but we think its impact will be modest.
RBA Governor Philip Lowe noted on September 1 the expansion of both fiscal and monetary policy would be necessary.
Treasury Secretary Steven Kennedy said on July 30 there would be three phases of fiscal support. The first would be to provide income support to people and businesses. The second would see income support maintained but increasingly targeted, while switching fiscal support to encouraging economic activity and employment. This second stage would also involve taking the opportunity to reform where it arises.
Kennedy said the third phase would “increasingly focus on the functioning of labour and product markets, and responding to accelerated structural change. Clearly, support for demand will still be required to lock in a declining unemployment rate”.
Fiscal policy’s power lies in its ability to create demand, with the only constraint being the political will to take on debt and potentially a credit rating downgrade.
Australia’s federal and state governments have ready access to capital markets and can borrow at historically low interest rates. The Reserve Bank is also willing to buy government bonds in the secondary market to keep rates low. It has already bought around $A61 billion of bonds since announcing the policy.
Without more fiscal stimulus, unemployment would rise to – and possibly remain at – an unacceptably high level, with damaging long-term consequences. Initial hopes that the economy would need only six months of intensive fiscal care were in hindsight short-sighted.
So far the federal government’s fiscal stimulus has been focused on Kennedy’s stage one and two. The Commonwealth has planned almost $A200 billion of spending and revenue forgiveness over a short period but its forecasts (even before Victoria’s second wave) were for a 2.5 per cent contraction in GDP growth (in 2020-21) and rising unemployment (to 8.75 per cent in the June quarter 2021).
Similarly, where the states have updated their formal forecasts, the outlooks remain poor, especially in Victoria. This is why the third phase is necessary.