Last year, in the face of the largest peacetime negative economic shock since the Great Depression, all of the arms of economic policy were moving in the same direction.
Fiscal support totalled a massive 15 per cent of GDP and the RBA cut its cash rate to a near-zero rate and took a range of unconventional policy actions, including a large scale bond buying programme. There were also key forbearance measures, such as safe harbour arrangements for corporate insolvencies and repayment holidays for mortgages.
This year, an economic upswing is already underway, underpinned by Australia’s success in managing the health implications of the pandemic.
In response, it makes sense that policymakers are choosing to phase out the large and expensive fiscal support programmes, such as the ‘JobKeeper’ wage subsidy. These support programmes have served their purpose to support the economy in the face of the initial shock and widespread lockdowns.
At the same time, removing these supports will create challenges. In part, because the support measures themselves have slowed down the process of economic adjustment to the post-pandemic ‘new normal’.
Although the economy is in an upswing, it will also be quite different to how it was pre-pandemic. In particular, closed international borders to people movement are weighing on the economy, particularly on tourism, education exports and on migration.
Although the rollout of a vaccine will help to allow the international borders to re-open from the second half of the year, we expect the pace to be gradual. After all, the virus is mutating, the vaccine will not offer complete protection and policymakers have become highly sensitive to even small numbers of COVID-19 cases.
The pandemic has also driven some permanent behavioural changes that affect the shape of the economy. More people are working from home, business travel has stalled and on-line retail sales have increased markedly. In short, the pandemic has accelerated the process of digitalization of economic activity.
All of these shifts will test some business models and many of the adjustments needed have yet to happen. A key indicator of this is that corporate insolvencies are tracking at less than half the normal rate, despite the economy having its first recession in three decades. As the fiscal support measures are removed we expect that business failures will rise.
This will leave policymakers with complex trade-offs to manage. On the one hand, some business failures are needed, because the post-pandemic economy will be different.
Allowing some businesses to fail, and jobs to turnover, may help to lift productivity growth. After all, studies by the Federal Treasury have shown that a key factor behind Australia’s weak productivity growth in recent years has been a loss of dynamism.
On the other hand, it is hard to be certain which business models are now completely unfit for survival and which are still being temporarily affected by the pandemic. For example, some businesses will struggle with the uncertainty of rapidly shifting state-border restrictions on people movement, but these restrictions are not likely to be a permanent feature of the post-pandemic ‘new normal’.
In addition, another ‘new normal’ challenge, is that monetary policy is near its limits. Lower for longer global interest rates have left the RBA with less capacity to provide additional support for the economy than at any time in at least the past 30 years.
With inflation well below target, the politically-independent RBA would ideally deliver more policy support. But the main levers to support the economy are now in the hands of the fiscal policymakers.
On a positive note, fiscal authorities have acknowledged this and have adopted an unemployment rate target, with the aim of getting the unemployment rate to fall below 6%. A benefit of this approach, if managed properly, is that it allows the economy to start to adjust to the post-pandemic new normal, while at the same time ensuring that the overall economy is moving in the right direction.
But many aspects of fiscal policy are inherently political. In the past, key decisions about how much stimulus the economy needs were made by the independent central bank. At the same time, the main allocation decisions in the economy were made by the market. Now, the government is set to play a much larger role.
Will the government choose to support Queensland’s tourism industry? Or Sydney’s foreign student apartment rental businesses? Or event organisers? How will fiscal policymakers determine if support is needed and who should get it, given the uncertainties about the post-pandemic new normal?
The policy choices are set to get harder and the political nature of these decisions is likely to mean we face more economic volatility in the future than we have seen in recent decades.
This article first ran in The Australian newspaper.