While there is clearly a supply-side hit to the economy there is also a demand problem, which means there won’t be an inflationary blowout.
The traditional measure of future inflation expectations – the 10-year break even bond yields – are falling, reflecting the market view that inflation will be no greater than 1.2 per cent over the next decade.
Gregory, who served on the RBA board from 1985 to 1995, says in the last two recessions high interest rates were used to contain inflation. Not so this time.
In the recession of 1982/83, when the US Federal Reserve chairman Paul Volcker was doing everything to contain inflation, the Hawke government introduced the accord to subdue inflation without losing jobs. Unemployment fell from 10.5 per cent in 1983 to 7.8 per cent two years later. Inflation, which had hit a high of 12.4 per cent in 1982, tumbled to a low of 2.5 per cent within two years.
Running out of policy room
In the recession of 1991, inflation was running as high as 8.7 per cent.
“There was a lot of pressure back then to reduce inflation, we didn’t want it to get out of hand,” Gregory says.
But unemployment was already higher than 10 per cent and GDP was tanking, so the RBA then had to cut rates.
In May 1991 the bank started cutting from 11.5 per cent to 5.75 per cent, all within a year. This would normally fuel inflation. But instead inflation plummeted to an annual rate of just 0.3 per cent by December and unemployment rose to a peak of 11.2 per cent in December 1992.
Unlike the 1991 recession and other downturns such as September 11 and the dotcom crash of 2001, and the Asian Financial Crisis of 1997, the Reserve Bank is now running out of conventional monetary policy room to stimulate – reaching the point at which cuts can’t be passed on.
“At the zero bound, in the absence of a strong policy response, the consequent downturn could perpetuate itself,” economist Peter Downes said.
Westpac’s veteran chief economist Bill Evans says this downturn is different to previous recessions because it’s not policy driven, but a sudden shock.
“We could see a lift in the unemployment rate, particularly through the June quarter and September quarter, but nothing like those horror recessions in the 1980s and 1990s that were largely caused by policy mistakes in response to rising inflation and rampant asset price bubbles in the late 1980s.”
AMP Capital’s Shane Oliver, who thinks there is “a rising risk of a recession”, said it could end up looking two ways – V or U shaped.
The V-shape is a “relatively mild” recession because any shutdowns would be temporary and growth would bounce back quickly once the virus runs its course. In that context unemployment would drift up a bit “but it wouldn’t be dramatic”.
The U-shape is if it does turn out like the last two recessions of 1983 or 1991 – the “recession Australia had to have” when the jobless rate jumped to double digits.
“A risk is that the disruption due to the virus runs for longer and is far deeper, triggering corporate insolvencies, significant job losses, rising defaults on mortgages, falling home prices resulting in a deeper recession and a sharp rise in unemployment to, say, around the 10 per cent level seen in previous recessions.”
NAB’s chief veteran economist Alan Oster said unemployment would need to rise by a full percentage point for Australia to be in a serious non-technical recession.
He expects that if the virus disruptions continue past May then a recession is likely to be recorded, driving unemployment higher.
And Bob Gregory will be walking down Elizabeth Street again with empty shops.