r/AusEcon

Ireland: During 2007-2010, the property and construction collapse exposed banking weakness that led to major government support and EU–IMF assistance.

Key variables: house prices -50%, GDP -10%, unemployment up to 15%.

Finland: The Finnish example of the early 1990s involved a housing-market collapse, a banking crisis and a deep recession.

Key variables: house prices around -40%, GDP -10%, unemployment up to 20%.

United States: The GFC housing crash contributed directly to mortgage losses, financial-market stress, a deep recession and rising unemployment.

Key variables: house prices around -30%, GDP -4%, unemployment up to 10%.

Australia: The GFC did not produce the same housing/banking crisis. Australia felt economic pain, but avoided the similar outcomes seen in the US and Ireland.

In Ireland, Finland and the United States, housing weakness appeared before the major banking and economic impacts.

During the GFC, Australia largely imported the shock from overseas. The housing market was not the origin of the crisis.

However, Australia's current housing price situation, driven largely by higher interest rates and policy changes, could be a problem because major housing downturns elsewhere have sometimes led to major economic distress.

PAYWALL:

A decline in living standards has become the new normal as rising interest rates, high inflation and stagnant productivity trap the economy in neutral.

Australia’s economic troubles deepened this week when the Reserve Bank of Australia raised interest rates for the fourth time this year, new inflation figures showed entrenched price pressures, and the government’s budget deficit got worse.

Australians will need to get used to this extended post-pandemic economic hangover as the new normal, which threatens to stretch from the current count of four years to become a lost decade for living standards.

Once the world’s economic poster child, Australia has belatedly caught the disease that has been afflicting other Western economies and fuelling the rise of populist politics overseas.

After lifting the official cash rate to a 15-year high of 4.6 per cent and warning that more increases were plausible, RBA governor Michele Bullock belled the cat by declaring the “bottom line is that productivity is doing nothing”.

Australia remains a wealthy nation, and unemployment is low. But economic evidence suggests a malaise has now set in.

The Albanese government appears incapable of a fundamental policy shift that economic experts say is required as a circuit breaker.

Leading academic economist and former RBA board member Warwick McKibbin can’t see anything changing under the current political structure of Labor, the Coalition and One Nation.

“It’s instructive to look at history around the world in these circumstances,” says McKibbin. “You don’t see too many success stories in countries without deliberative corrective actions.

“At some point the distortions will build and cause a political backlash that is either positive or negative.”

The evidence is piling up. The RBA’s preferred measure of underlying inflation has been above the 2 per cent to 3 per cent target for more than 80 per cent of the time over the past four years, only briefly dipping back inside the band in early 2025.

Treasurer Jim Chalmers has a point that fuel prices have soared because of the conflicts in Iran and Ukraine that are beyond the government’s control.

But Bullock made it clear that the homegrown price pressures predating Donald Trump’s February 28 strikes on Iran were her bigger concern.

The treasurer and governor are not totally at odds, but they put different emphasis on the contribution of international and domestic factors driving inflation.

The inflation data shows tradeable goods and services, which are highly exposed to international factors – such as fuel and food – rose a moderate 2.9 per cent over the 12 months to August, compared with 4.5 per cent for non-tradeable goods and services more influenced by domestic factors.

Household electricity bills have also jumped over the past four years as Australia replaces its ageing coal-fired power plants with renewable energy sources that Labor pledged would reduce prices.

Labour productivity has flatlined since 2020, which, as Bullock warns, means economic growth above a mediocre 2 per cent will fuel inflation and real wages cannot grow.

Hence, another rate rise was required on Tuesday, and there is probably more pain to come for borrowers after headline inflation rose to 4 per cent in August, according to the consumer price index released on Wednesday.

“I think the RBA leadership has lost patience and realised the costs of inflation are both economic and political in terms of 25 per cent of the Australian population thinking Pauline Hanson would make a good prime minister,” says Hogan.

“I’d be flabbergasted and despondent if the RBA doesn’t hike again in November.”

On the fiscal side, Chalmers unveiled on Monday an “underlying” budget cash deficit of $22.3 billion for 2025-26 and a “headline” cash deficit of $36.1 billion. The deficits are roughly double compared with the previous year and a sharp reversal from the two initial surpluses when Labor came to office.

On this measure, Labor’s historically high spending is adding to demand pressures and working against the RBA’s attempts to slow the economy, despite Chalmers’ insistence that the government is managing the budget responsibly to play its role in the inflation fight.

The take tax is also at a 20-year high.

The budget deterioration is occurring as tetchy global bond markets push up the cost of government debt to a two-decade high, an unnerving development that Chalmers discussed with financial regulators on Thursday.

Hogan says it is a risky time in the global economy and financial markets because of big structural changes, as evidenced by the “mini crash” in the bond market.

“The low cost of capital for the past 20 years – that world has gone,” he says.

“Governments have been undisciplined on their budget management, and now have competition for debt from big tech investment plans for artificial intelligence and data centres.”

DP Advisory Group director and former Treasury official Dimity Pascoe says Australia is experiencing the “new normal” of stagnant productivity and sluggish economic growth.

EQ Economics managing director Warren Hogan – who has been warning for more than two years that a cash rate of above 5 per cent (which would need at least two more rate rises) will be required to control inflation – says the RBA has given up on its “softly, softly” approach to taming inflation.

Pascoe blames 15 years of policy inertia from successive Labor and Coalition governments following the Howard Coalition and Rudd Labor governments in the 2000s.

“Even if there was a policy change today to the best possible economic reforms, it would take at least a couple of years to implement and about three to five years for the benefits to start to flow through.”

“And if we don’t change policy, a [lost] decade is not unreasonable.”

McKibbin says a circuit breaker is required.

“If nothing changes and the AI boom is not what the most optimistic people think, we will get back to a ‘banana republic’ speech at some point that jolts the political system to reform the economy again.”

McKibbin’s rekindling of the “banana republic” term refers to the landmark radio interview former Labor treasurer Paul Keating gave in 1986, warning that if Australia did not reform and modernise its old-world economy, people’s living standards would suffer.

“If this government cannot get the adjustment, get manufacturing going again, and keep moderate wage outcomes and a sensible economic policy, then Australia is basically done for,” Keating said.

“We will just end up being a third-rate economy... then you are gone. You are a banana republic.”

Keating created the necessary political urgency for the then Labor government to push through tough economic reforms, including slashing tariffs, financial deregulation, privatising government assets, and cutting spending to turn the budget from deficit to surplus.

In contrast, Prime Minister Anthony Albanese and Chalmers assure Australians that the current Labor government’s policies have the nation on the right trajectory.

Albanese is inherently cautious, preferring to assure Australians of his sensible middle-ground approach to managing challenges.

He allowed Chalmers to take a big political risk on contentious tax changes to negative gearing, capital gains tax and discretionary trusts in the federal budget in May, but another big U-turn is highly unlikely.

Piecemeal cost of living handouts

Labor’s record shows it is more likely to focus on piecemeal cost of living handouts, the October 1 ban on credit card surcharges, and industry bailouts such as the latest $200 million federal-state lifeline for the Bell Bay aluminium smelter in Tasmania.

After Bullock called out the productivity problem, Chalmers insisted that his last budget had the “biggest and broadest productivity package in any budget for some decades”.

This included cutting an estimated $10 billion in compliance costs for business, such as for project approvals, tax system compliance, financial sector red tape, international trade and building regulations.

He listed efforts to speed up foreign investment screening, overhaul environmental approvals for major projects, freeze the national construction code until mid-2029 to give builders certainty and work with the states on competition reforms and more consistent rules across borders.

To be sure, there are some useful under-the-radar changes happening. But it is a struggle to find an economist who thinks the government’s current agenda will revive flatlining productivity.

Pascoe says a personal tax system that rewards risk-taking and greater efforts to boost competition and cut red tape are required.

McKibbin says some of Labor’s policies are making the productivity problem worse, despite the government’s claims.

“There is a lot of showcasing and selling things that aren’t true, but not a lot of reform,” he says.

“Government is becoming too large a share of the economy and that is distorting private sector decision-making.

“The labour market reforms were always going to cause productivity problems. Taxes are being raised and destroying incentives.

“Even if you want to keep the revenue base, you need to switch from relying on distorting income tax on hard work to a consumption-based GST.”

For Chalmers, the politics is turning nasty and personal.

Hanson called on him to adopt One Nation’s proposal to turn superannuation into higher take-home pay, and then dutifully resign as treasurer.

The Coalition recycled old social media posts and videos of Chalmers as shadow treasurer heckling then prime minister Scott Morrison and treasurer Josh Frydenberg for interest rate increases and weak productivity.

Angus Taylor accused Chalmers of continuing to act like a media adviser – his role when working for former treasurer Wayne Swan – more focused on spinning the message than fixing the problems.

In response, Chalmers demanded that Taylor specify where the Coalition planned to cut government spending and warned that the conservatives would unleash cuts to Medicare and other services. He also pointed out that Taylor had opposed Labor’s tax cuts at the last election and had pledged bigger budget deficits – at least for the first two years.

The frustration is growing within Labor. In Canberra, a small group of Right faction Labor MPs privately say the government needs to do a better job on economic reform, budget management and productivity.

The Left of the party, which now has a majority in the Labor caucus, has less interest in economic policy and is more intent on blaming the RBA for the government’s problems, says an MP from the Right.

This week, NSW Labor Premier Chris Minns took a veiled swipe at the Albanese government over inflation, saying his administration has been careful with public money, including making difficult decisions to offset new spending, so as not to exacerbate the situation.

Minns declined to defend Chalmers from allegations that his spending was helping drive inflation and higher interest rates.

The premier’s divergence followed fresh criticisms from former RBA governor Philip Lowe, who said the government should be running large budget surpluses and cutting spending to take pressure off inflation and interest rates.

“Australians enjoy one of the highest standards of living in the world,” Lowe told a podcast hosted by The Institute of Public Affairs.

“The problem as I see it is that living standards have stagnated. For seven years now, there’s been no net growth in per capita income. Now that’s staggering.”

There is no love lost between Chalmers and Lowe, who had his seven-year term as governor and 43-year career at the RBA terminated by the treasurer.

Chalmers did not reappoint Lowe after his infamous forward guidance about interest rates being unlikely to rise until 2024 – they rose in 2022 – and replaced him with Bullock to implement the findings of an independent review of the RBA.

But Lowe is hardly alone in his criticisms. Former Treasury secretaries Ken Henry and Martin Parkinson have issued similar warnings about how the budget should be in surplus during a revenue boom and the need to lift productivity to boost living standards.

Of course, Australia could get lucky again, just as it did from the China-driven mining boom of the past 20 years.

“AI could help us win the lottery on productivity,” says McKibbin.

But don’t bet on it.

“My guess is the extreme upside on AI is very low probability,” he says.

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