Amid job cuts at Qantas, Canva and Nab, the R-word is back in circulation. Is there anything the government can do?
The acknowledgment last week by Michele Bullock, the governor of the Reserve Bank of Australia, that the cumulative effect of this year’s five increases in interest rates “is going to make people feel like it’s a recession” has put the R-word back into circulation.
It comes as Qantas becomes the third major Australian company in three weeks to announce large-scale job cuts, following restructures at Canva and National Australia Bank.
Although there is no universally accepted formal definition of a recession, a widely used rule of thumb is that a recession is denoted by two or more consecutive quarters of negative growth in real GDP.
In my long-held view, that’s a flawed yardstick – it would have excluded the recession of 1974, when real GDP only fell in one quarter (albeit by an out-sized 2%), and it would have identified the second half of 1977 as a recession.
When I became unemployed I expected to find a job in no time. As months passed, I realised I was being shunned | John EmersonRead moreA better gauge, in my view, is the so-called Sahm rule, so-named after its inventor, former Federal Reserve economist Claudia Sahm, which identifies a recession as occurring when the three-month moving average of the unemployment rate rises by half a percentage point or more relative to the minimum of its three-month moving average over the previous 12 months.
Reserve Bank staffers consider that a three-quarter percentage increase in the three-month moving average relative to its low over the preceding 12 months is more appropriate in the Australian context (given the greater volatility in our monthly unemployment rates than in the US).
That definition of a recession wouldn’t be triggered if the RBA’s latest forecasts, which see the unemployment rate rising to 5.1% by the end of 2028, come to pass.
But if the unemployment rate were to drift up at the same rate as it has done, on average, over the past six months, then the “modified Sahm rule” would be triggered in January next year.
A genuine recession could be brought on by the bursting of the AI bubble (if a “bubble” is indeed what it is). To the (as-yet-unknown) extent the broader financial system turns out to have become entwined in some of the murkier reaches of that bubble, a GFC-like downturn may well ensue, albeit not necessarily on the same scale as the 2007–2009 episode, but nonetheless one from which Australia would not be immune.
Of course there’s nothing that the Australian government or the Australian central bank could do to prevent such a scenario from unfolding – although if it did they would no doubt seek to do whatever they could to mitigate its local effects.
Another plausible trigger for recession is if the RBA ends up overdoing the tightening of monetary policy. That’s always a risk, because monetary policy always operates with “long and variable lags” (as Milton Friedman famously put it 65 years ago), and because the data which informs judgments about monetary policy also comes with a lag.
Whenever inflation rears its ugly head, the probability that a central bank can calibrate exactly the right amount of monetary policy tightening (increases in interest rates) to bring it back down to whatever level it is targeting without inducing a recession is pretty close to zero. It is far more likely either to do “too much”, inducing a recession, or “not enough”, failing to bring inflation down to its target. It can only ever know whether it has made a mistake, and if so which one, with the benefit of hindsight.
With the benefit of hindsight, the RBA didn’t tighten monetary policy enough, or keep it tight for long enough, between 2022 and 2024. Inflation did come down from its late 2022 peak of almost 8% – but it didn’t stay down once the RBA started cutting rates in 2025.
Conversely, the RBA’s peers in Canada and New Zealand, again with the benefit of hindsight, arguably tightened too much – in both countries the preferred measure of “core” or “underlying” inflation came down to the target range, and has stayed down, but at the cost of “technical recessions” and much bigger increases in unemployment than occurred in Australia.
Contrary to what some of its critics assert, the Reserve Bank doesn’t believe that higher unemployment is a cure for inflation. Rather, it accepts that higher unemployment is an unavoidable side-effect of the cure, which is slower growth in demand.
And it would seem from their comments in the lead-up to, and after, the most recent increase in interest rates, that Bullock and her colleagues are now more willing to accept higher unemployment as a side-effect of whatever amount of monetary policy tightening is required to bring what has now been five years of almost continuously above-target inflation to an end.
The RBA is split over the risks of the latest rate hike. For Australians, it’s a bitter pill | Nicki HutleyRead moreWhat has this got to do with the federal government’s thinking about government spending in the lead-up to the mid-year economic and fiscal outlook (Myefo) which the treasurer will present around the middle of next month?
Well, if the government wants to reduce the risk that the Reserve Bank raises interest rates to a level that induces a recession (however defined), it should help rather than hinder the Reserve Bank in its efforts to bring aggregate demand into line with aggregate supply.
And the best way it could do that would be to ensure that the budget deficit for this year, 2026-27, is smaller than that for 2025-26, rather than being $28bn (almost 1 percentage point of GDP) larger, as this year’s budget indicated that the headline cash deficit would be.
Of course, it could do that by raising additional revenue. But I’m more likely to see a thylacine on my front lawn of a morning than for that to happen.
So the only alternative is for it to cut spending – either the spending it does on its own account, which shows up as “public demand” in the GDP statistics, or the cash it transfers to households and businesses, which shows up as “private demand” in the GDP statistics when households and businesses spend it.
And there are plenty of options – starting with scrapping the obscene Western Australia GST deal, under which the federal government is gifting Australia’s richest state with $6.5bn a year that it doesn’t need in order to provide its population with the average level of services at the average level of efficiency while levying on them the average level of state taxes and charges. How a government which is ostensibly concerned about equity as well as fiscal prudence can continue doing that defies explanation.
Beyond that, the government could reduce or eliminate subsidies for the purchase of electric vehicles and batteries which are primarily taken up by higher-income households, and for which higher fuel prices are now providing an effective “market signal”. It should make greater use of means tests in determining eligibility for financial assistance or access to otherwise “free” services provided by governments.
And it could defend all of that, politically, by explaining, with good reason, that it was in order to reduce the likelihood of any further increases in interest rates by spreading the burden of “fighting inflation” more broadly and more fairly, and reducing the risk of inadvertently and unnecessarily tipping the Australian economy into a recession that we don’t have to have.