US recession, the economic flu we could all do without — fingers crossed

Recession talk is in the air again. A survey just days ago in The Wall Street Journal put the chance of a recession in the US within the next 12 months at 44%.

In a note to clients, ANZ Bank’s chief economist Richard Yetsenga put it like this: “History suggests there is a good chance of a US recession when the … US Fed tightens [lifts interest rates] with unemployment this low and wage growth this high, or the Fed tightens with inflation this high. But history is not destiny.”

America is certainly in a precarious position. The questions for Australia are: if the US enters recession could it spread here via contagion, and; are we exposed to the same forces that might cause a recession in the US?

If Australia has a recession it will place a lot at risk. Forget full employment, for starters. I’ve been truly excited about our new PM making full employment a genuine policy goal. I want to live in a country where people can find work easily, one with thriving wages growth. A recession would leave us even further from that ideal. It would deal serious harm to the prospects of the Albanese government and give Peter Dutton’s opposition a rhetorical line about Labor’s economic management that will be as devastating as it is unfair.

A recession is, in short, the last thing we need.

How can we get there from here?

At the moment, unemployment is at very healthy lows, jobs growth is strong, the number of advertised jobs is high. Could that reverse quickly?

Well, as anyone who has woken on a bleary Sunday morning can attest, the highest of highs can be followed by the deepest and most crushing lows. Our recent economic growth has not been the stable and dull sort we became accustomed to between 2010 and 2019. Instead it has been rapid, lifted up and propelled forward on the frothing waves of a historic shift in fiscal policy as the next chart shows. It’s like the paper roll that is slowly issued from a seismograph after major earthquake — and where you might expect an aftershock or two.

Contagion from a US recession would certainly harm growth in Australia. But it might not be decisive in pushing us into recession and it might even make life easier in some ways. A US recession could lead to falls in prices of global commodities that are forcing up inflation in traded items and obviate some of the need to crush inflation in domestic items. In short, US recession creates cheaper oil and shipping costs, taking some of the pressure off the RBA to do all the work.

If contagion is not necessarily the major reason we might face a recession, what is? The fact we face the same circumstances of high inflation, high budget deficits and low interest rates.

Returning fiscal policy to normal levels would mean removing a lot of support from the economy. But we’re not simply returning fiscal policy to normal levels. Treasurer Jim Chalmers is likely to use the budget to tighten the screws. He is unlikely to be immune from the surplus obsession that afflicted his mentor Wayne Swan. (Swan, in turn, caught it from his predecessor, Peter Costello, who was the recipient of particularly large amounts of unexpected revenue.)

I suspect Chalmers would love to finish his term as treasurer able to say he put the budget back in balance.

The other reason Chalmers will be inclined to engage in fiscal tightening is it will help reduce inflation, so we can expect a heavy cut in the contribution of government spending to growth. Chalmers won’t design in a cut sufficient to create a recession, of course, but he’s not the only relevant actor.

The RBA is also on the move — it lifted rates by half a percentage point at its most recent board meeting and is indicating it may do the same again at the next one. The shift in tone has put consumer confidence in the doldrums.

America’s situation is even more tense, with sharemarkets in freefall. The stock prices of old industrial behemoths Ford and General Motors are down 45% over the past year. Tech companies that have added so much dynamism to the US economy since 2000 are in many cases faring even worse. Facebook is down 54% and Netflix is down 65%. Oil stocks are up, but “big oil” is a misnomer these days — major oil companies are a tiny part of the US economy and its public market.

In the US, monetary policy works differently from Australia. People lock in their home loan rate for as long as 30 years and only a tiny share of mortgages have a variable rate. When the Federal Reserve changes interest rates it doesn’t work by squeezing the household budgets of borrowers. Instead it makes asset-owning households feel poorer by hitting asset prices (the so-called “wealth effect”) and by changing business borrowing.

Fed chair Jerome Powell lifted rates a whopping three-quarters of a percentage point at the June meeting and on Wednesday told Congress that lifting rates could cause a recession.

“Would you agree with the perspective that if interest rates go too high too fast it could drive us into a recession?” asked Democrat Senator Joe Tester in a congressional hearing. “It’s certainly a possibility,” Powell replied. “Events around the world have made it more difficult to achieve what we want.”

Faith in policy

Powell raises a vital point. The US Fed doesn’t get to just choose any combination of growth and inflation it wants. Neither does the RBA. Achieving an acceptable combination is difficult. Reducing inflation affects growth. Is there a way to preserve growth and crush inflation at the same time? Or are such hopes likely to place us in a dead-end alley where you have to track backwards before you can find a route out?

Growth and inflation are in tension. One requires more spending, one less. It’s like a chess problem where you must sacrifice pieces to win. Are we in a position like that? Will we sacrifice growth to defeat inflation? In a way, that’s exactly the point of an inflation-targeting central bank. Its independence exists so that it will focus on inflation — even at great cost — without having to worry about being voted out.

Of course, with a review of the RBA on the horizon, its technical independence may matter less than usual. It might not have the same courage to put us into recession as it would at other times. This would preserve growth, but at the longer-term cost of letting inflation expectations spiral upward. That might be even worse in the long run.