How Will Australian Government Support Economic Recovery After the Easing of Restrictions?
While the pandemic interrupted a 28-year run of uninterrupted growth, thanks to the government’s macroeconomic policy support, appropriate force at the onset of the pandemic and the prompt reopening of domestic activity, Australia’s economic downturn since the initial Covid onset was much milder and the rebound was relevantly swifter compared to most OECD countries.
Although the Delta outbreak has delayed the recovery progress of the Australian economy, we have noticed that the current episode is materially different to the past sever shocks that point to a brighter outlook in Australia. Particularly we are at the first stage of reopening since last week, once the recovery resumes, with government’s supports at an appropriate level, we will be on a fast-track return to a stronger economy.
According to RBA’s outlook released in September, it is expected that the economy to be growing again in the December quarter 2021, with the recovery continuing into 2022. The key drivers here are the increasing rate of vaccination and the easing of restrictions on economic activity.
While it is hard to be precise about the pace and timing of this bounce-back, in the RBA's central scenario, economic activity is expected to be back on its pre-Delta track by the second half of next year.
It is reasonable to ask here: will government maintain current generous supports or provide alternative support to help with recovery? Here are what we found.
Monetary Policies – a package of ongoing monetary policies and extended bond purchase program.
Since 2019, RBA has been providing an ongoing package of policy measures and important support to the Australian economy as it deals with the Delta outbreak. This package includes:
· a record low cash rate.
· a target of 10 basis points for the April 2024 Australian Government bond.
· a bond purchase program under which we have already purchased $200 billions of government bonds, with more to come.
· the low-cost term funding facility (TFF) for Australia's banks, under which $188 billion has been provided for 3 years.
This monetary policy package aims to keep funding costs and lending rates low across the economy; ensure that the financial system is very liquid; supports household and business balance sheets; and contribute to an exchange rate that is lower than it would be otherwise.
RBA emphasized in its board paper in September that the policies will continue to support the recovery of the Australian economy over the months ahead. And RBA has decided to purchase $4 billion of bonds each week, as previously announced, but they will extend the period until at least mid-February next year, to provide further support to the economy during the recovery phase.
The RBA's purchase program started later than that of most other central banks but recently has been expanding faster relative to the government bond holding. This represents an efficient and effective support to the economic recovery.
Monetary Policies – RBA’s outlook for the cash rate
According to Phillip Lowe, the Governor of RBA, who gave a public speech in September after RBA’s board meeting, there is no plan for RBA to uplift the cash rate in short term. “In today's low inflation world, we do not want to run the risk that we increase the cash rate on the basis of a forecast that ultimately does not come to pass, leaving inflation stuck below the target band.” And the Board has said that it will not increase the cash rate until actual inflation is sustainably within the 2–3 per cent target range. “But we have to get there first. Our judgement is that this condition for a lift in the cash rate will not be met before 2024.”
Another pre-condition for meeting this condition requires a tighter labor market - wages will need to be growing by at least 3 per cent. But so far this is remained well short, even in industries where there has been strong demand for labor, wage increases remain mostly modest with just 1.7 per cent over the year. It will take some time for wage increases to lift to a rate that is consistent with achieving the inflation target.
Clearly, the record high housing price is driven by the record low interest rate. Some analysts have queried about if RBA will lift the cash rate to cool the property market. However, as the Governor said, “this is not on our agenda, this is a poor trade-off in the current circumstances”, as this would also mean fewer jobs and lower wages growth.
“Concerns about the level of housing prices are not best addressed through increasing interest rates and curbs on lending,” as he pointed out, the high pricing issue supposed to be addressed by structural factors that influence the value of the land upon which dwellings are built, as he discussed, which include: the design of our taxation and social security systems; planning and zoning restrictions; the type of dwellings that are built; and the nature of our transportation networks. These are all areas outside the domain of monetary policy and the central bank.
Fiscal Policies - Short-term fiscal policy will remain responsive.
Compared to monetary that mentioned above, fiscal policy is the more effective policy instrument in responding to the Delta outbreak. This is because fiscal policy can use the public balance sheet to offset the hit to private incomes during the lockdowns. In contrast, monetary policy works mainly on the demand side and the effects on income are felt with a lag.
In the short-term, fiscal policy will continued to be highly responsive to developments in economic conditions. The 2021-22 Budget committed an additional $41 billion in direct economic support, bringing total support since the beginning of the pandemic to $291 billion as of May 2021.
Source: Federal Budget 2021/2022
Building on that support, the Government is working with states and territories to provide further financial assistance to workers and businesses affected by lockdowns and restrictions in Covid hotspots. Current direct financial assistances include Disaster Payment for individuals and households; Commenwealth JobKeeper and state’s JobSaver Payment for business; and HomeBuilder program to help with construction industry. Post-pandemic reforms will seek to address longstanding challenges such as stagnating growth in living standards and weaker productivity growth that had led to disappointing wage outcomes for workers.
Fiscal Policies - Over the longer-term, fiscal spending pressures will grow, but under controlled. Tax reform would be necessary.
Under current policy settings, ageing related costs and generous government support through Covid will cause public debt to keep rising to 2060. But luckily, the government entered the pandemic from a strong fiscal position. Its newly revised fiscal strategy is to support the economy until the recovery is well entrenched and the unemployment rate is back to pre-pandemic levels or lower and then to switch focus to stabilising and then reducing public debt in the medium-term.
A legacy of the pandemic is higher public debt due to previous budgetary deficit. Future fiscal strategy is suggested to be framed in the context of future budgetary pressures and monitored by an independent fiscal institution. Tax reform would be necessary to help with budgetary deficit and reduce Australia’s reliance on taxing personal incomes, which leaves public finances vulnerable to an ageing population. According to OECD’s recommendations, possible measures of tax reform that government may take include - broadening the base and provided additional personal income tax cuts, potentially increasing the GST tax rate, reducing capital gain tax discount, reducing private pension tax breaks, and replacing stamp duty with a well-designed recurrent land tax.
Fiscal Policies – The digital revolution in financial sector can contribute to a stronger, more sustainable, and inclusive recovery.
Financial institutions provided an important buffer against the economic shock. To promote a sustained recovery, reforms that improve access of small innovative firms to credit and protect the financially vulnerable is a key.
The digital revolution in financial services can improve lenders’ ability to assess credit risk in the absence of collateral or business history. This can facilitate new sources of finance for young businesses. Extending open banking to facilitate switching of providers could inject much-needed competition to the lending market and improve access to finance.
Furthermore, many households lack sufficient financial knowledge and capability. To address these obstacles, providing alternatives to bank finance through online service could help to activate consumer and business activities and raise productivity.
Uncertainties and Positive Factors
One of the uncertainties here is the possibility of further significant restrictions on activity. Another source of uncertainty is how Australians will respond to the easing of restrictions, given that the easing is likely to take place with COVID-19 still circulating in the community. Much will depend upon our attitude to risk and how our society deals with the ongoing rate of infection.
One of the positive factors underpinning the view that the economy will bounce back is the substantial income support being provided by the Australian Government and by the states and territories. And with consumption restricted by the lockdown, the aggregate household saving rate is keeping at high level.
Once restriction easing, we are likely to see a boom in consumption and investment. Property investment as one of the major sector of household investment may see more money flood in as a result.
It is also relevant that broader measures of household wealth have increased recently. Housing prices are around 20 per cent higher than they were before the pandemic and Australian equity prices are around 10 per cent higher.
This lift in the net wealth of the household sector is one of the things that suggest that once the restrictions are eased, households will be well placed to start spending again.
Implications
Overall, both monetary and fiscal policies will keep providing supports to help recovery from Covid and further stimulus the economy. Low interest rate policy would still be the one that impact mostly in property development industry and in CRE lending market. RBA has clearly given their attitude towards the idea of increasing interest rate to cool off current property market heat – it is not likely to happen. Preconditions of increasing interest rate includes inflation rate reach 2-3 per cent and a stronger wages growth rate, as expected to be achieve around 2024, making 2024 a sensitive point of time for the market. In this well-supported environment, it’s likely to see house price will stay at a high level, unless other measures taken.
Regards to fiscal policies, HomeBuilder program would be a closely relevant one for property and construction industry. The Government announced it would extend the construction commencement requirement from six months to 18 months for all applications. It’s expected to see once restriction easing and board open, construction industry will see a boom period simulated by the program, which may cause construction costs soar in short period.
References
The Treasury - Economic Response to COVID-19
https://treasury.gov.au/coronavirus/sme-recovery-loan-scheme
Delta, the Economy and Monetary Policy
https://www.rba.gov.au/speeches/2021/sp-gov-2021-09-14.html#fn0
Uncertainty and Risk Aversion – Before and After the Pandemic
https://www.rba.gov.au/speeches/2021/sp-so-2021-06-02.html
Australia: Post-pandemic reforms should strive for a return to strong, well-distributed growth
Creating jobs and rebuilding our economy
https://budget.gov.au/2021-22/content/jobs.htm