Stimulus Extension Needed
The second half of 2020 was shaping up much better in Australia than first half until the resurgence of COVID-19 infections in Victoria. The re-imposition of stage 3 restrictions in Melbourne, the closing of the NSW/Victoria border and the appearance of small, community spread infection clusters in NSW threatening a return of some NSW restrictions, are likely to reduce and possibly cancel the previously expected rebound in GDP growth in Q3. As a result, unemployment may stay higher for longer and household and business spending may become more cautious.
If an extended and deeper recession is to be avoided, something needs to fill the hole in income and spending created by the latest health response to the rising COVID-19 infection rate. The bridge to economic recovery now appears to be several months longer than it was even a month ago. The Government needs to respond accordingly, and it means at the very least that Government business and household income support measures legislated to end in late September will need to be extended probably to the end of 2020 before tapering.
The Government will deliver an Economic Statement on 23rd July detailing the outcome of its review of emergency income support measures such as JobKeeper and JobSeeker payments. The design of the programs can be tweaked to ensure income support is being provided where it is most needed but the key point is that the scale of spending on the programs needs to be maintained for longer, certainly beyond end-September.
Extended fiscal stimulus will drive up the already high Budget deficit expected in 2020-21 and add to Government debt but these near-term outcomes should not prevent action. By spending money on income support in time of recession the Government limits the likelihood of a negative spiral of lower income driving down spending resulting in even lower income and spending. Effectively, the Government is moderating the depth and length of the recession and helping the economy to return to growth more quickly. Higher near-term deficits and borrowings are serving to reduce budget deficits and borrowings down the track.
Very low interest rates for months and probably years to come present another reason for the Government to spend and borrow more. The Government can borrow new money and refinance maturing borrowings with little or no upward pressure on debt servicing costs.
The RBA has set the cash rate at 0.25% since March and expects the rate to be no higher than 0.25% for possibly the next few years. The RBA is also working to ensure that the thee-year Government bond yield is no higher than 0.25% but admits that over the past month it has had to conduct few bond purchases to hold the yield down. Other forces are at work holding down interest rates. Essentially, private sector savings are under greater pressure to grow than opportunities to invest in the current weak economic environment.
Short-term Australian government bond yields no higher than 0.25% and 10-year bond yields less than 1% yield are entrenched and provide an almost limitlessly cheap borrowing environment for the Government.
The argument that running big budget deficits and building up Government debt presents a burden for future Australians is wrong if the Government is acting to counter unduly weak private sector spending and borrowing. Instead, if the Government did not spend and borrow more when the private sector is doing the opposite, the Government would be adding to the forces keeping the economy weaker for longer and presenting a much worse economic legacy for future generations.
If the Government does as we hope on 23rd July and announces extended spending on income support programs together with spending initiatives that help to bolster the productive capacity of the economy as it starts to recover, the impact of renewed Victorian COVID-19 restrictions will be limited to restricting Q3 GDP growth.
Our new base case forecast is that after falling in Q1, Q2 and possibly Q3 2020, GDP growth will lift sharply in Q4 and in 2021. This growth outlook, however, is subject to uncertainty even if the Government extends fiscal stimulus as we hope on 23rd July.
The main cause of uncertainty remains that COVID-19 infection is proving hard to contain. There is a risk of more outbreaks and setbacks releasing restrictions on economic activity. The possibility of a stop-start economic environment developing is itself confidence sapping. The willingness of the Government to keep spending and extend income support measures as required is crucial and will help to ensure that the economic growth falls less and recovers better than would otherwise be the case.