There’s been a lot of coverage in both the financial and mainstream media about the possibility of a recession later in 2023 and into 2024. Interest rates have been rising (at the fastest pace on record), inflation remains stubbornly high (despite higher interest rates), and there’s no shortage of geopolitical uncertainty–tragically the war in Ukraine wages on, U.S.-China tensions have re-ignited, and North Korea is once again launching missiles. Turmoil in global banking circles (including the demise of Silicon Valley Bank in the U.S. and Credit Suisse in Europe) have only added to macroeconomic woes.
In fact, just last week the International Monetary Fund (IMF) lowered its expectations for global growth in 2023. The IMF is now predicting economic growth will be “feeble and uneven” for the rest of the decade, and come in at just 2.8% for 2023, down from 3.4% in 2022. The slowdown will be felt particularly keenly across advanced economies, where growth is expected to be a meagre 1.3%, with both the U.K. and Germany economies forecasted to decline.
Australia is no exception, with the IMF forecasting a very modest 1.6% growth in 2023 followed by 1.7% in 2024–below population growth of nearly 2% per year, suggesting that GDP per capita is likely to fall each year. This is even more dramatic given the current state of inflation, which the IMF expects to be 5.3% in 2023 and 3.2% in 2024. These numbers are both well above the Reserve Bank of Australia’s (RBA) target band of between 2% and 3%, suggesting pressures on the cost of living for Australians are likely to extend a while longer.
A Long Time Between Drinks (Technically Speaking)
According to the numbers, Australia entered a recession in the first half of 2020 when the government imposed severe restrictions on the economy. Before that, the previous recession in Australia was what Paul Keating famously called ‘the recession we had to have’ in 1990-91. In between, the 29-year period of continued economic growth was an extremely long time for a developed nation to go without a recession–actually, the longest ever!
While there is some debate about the official definition, a recession is generally called following two consecutive quarters of declines in real GDP (which equals the nominal, or recorded, rate of GDP minus the rate of inflation). With inflation last year tracking at the highest levels since 1990, it’s up for debate whether Australia already entered another “technical recession” in 2022.
Up (down, up) and to the Right
Regardless of the technicalities, recessions are a normal part of the economic cycle. Over time, the average output of the economy (measured by Gross Domestic Product, or GDP) has consistently grown as the population has increased and technological innovation has improved productivity (e.g., development of computers). This long-term trend in economic activity is commonly referred to as “full employment” or the “potential” or “natural” level of economic output.
However, this growth has not occurred in a straight line. There have been times when economic activity has been above this trend (when the economy is “overheating”), before it inevitably peaks and enters a decline or contraction, which is more commonly known as a recession. Eventually these economic declines will subside in a “trough” before economic growth returns once again, in a “recovery” phase.
Why Do We Have Recessions?
There have often been periods of time when the economy has been weak, and when output and production, consumer spending, and personal incomes have declined.
Originally, the more severe economic drawdowns came from exogenous factors (extreme weather events or plagues wiping out crops, for example). As the economy has evolved over time, there’s been a range of new and different causes. This has been a huge topic of discussion, and researchers have proposed a bunch of explanations such as the “Real Business Cycle” theory, monetary theory, and the effects of inventory management, business profits, credit and interest rates, and other variables.
Each of these theories is well-researched and has sophisticated financial modelling to support it. Unfortunately, while history may rhyme, every business cycle is unique and can have a different underlying driver (or combination of drivers).
The U.S. recession during 1973-75, for example, followed the Yom Kippur War that began in 1973. OPEC (The Organization of Petroleum Exporting Countries) raised oil prices sharply when the war began, causing high rates of inflation. In turn, the U.S. Federal Reserve began to dramatically restrict the money supply (by increasing interest rates), and a recession ensued.. Was the “cause” of this recession the oil shock, tighter money supply…the war?
Additionally, there’s a growing body of research known as behavioural economics which suggests that economic downturns are the result of (or greatly exaggerated by) human psychology. Indeed, it’s been well-documented (and is widely known) that human psychology changes through the various stages of the business cycle.
Expectations start low as people remember the previous downturn (“climbing a wall of worry” is the common phrase), before “animal spirits” eventually emerge. At some point, this leads to optimism, eventually euphoria and finally speculation–look no further than former Federal Reserve Chairman Alan Greenspan’s warning of “irrational exuberance” in 1996, the stock market (“dotcom”) bubble in the late 1990s, and the two most dramatic economic downturns in recorded history, the Great Depression and the Global Financial Crisis!
Not All Recessions Are Created Equal
While it may be tempting to think of a smoothly oscillating/undulating curve, there’s no trend to business cycles. They don’t occur at predictable intervals and they never have the same length or intensity. Researchers have written about ‘cycles’ lasting as little as one year and as previously mentioned, Australia had a record 29 years without a downturn. Recessions can range from mild to severe (to the point of a “depression”) and the following recovery can be anywhere from slow to rapid (such as coming out of the pandemic restrictions). And despite the extensive research on the topic, they are notoriously difficult to predict. As the saying goes, economists have predicted nine out of the past five recessions.
Can Recessions Be a Good Thing?
With a constant barrage of negative news about the economy, it’s easy to fall into the trap thinking that poor economic times are ahead. This is in part by design. The RBA wants to slow the economy down. Unemployment is at such low levels (a record 3.5%, the lowest in 40 years) that businesses are screaming for staff. They’re certainly unable to grow the way they’d like, and in some situations simply closing up shop because they’re unable to find suitable employees. What’s more, an economy running too hot causes too much inflation, which is heavily impacting the cost of living for everyone in the country–especially those on low and fixed incomes who can least afford it.
Just like the human body must rest between tough training sessions to get fitter and stronger, a period of slower growth (and yes, sometimes even a recession) is exactly what’s needed to re-energise the economy for future growth. And remember, as researcher Hyman Minksy wrote in 1982, business cycles will continue “as long as the economy remains capitalist and innovation in industry and finance continues.”
Markets & Commentary
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