Analysis: Australia Stimulus May Not Prevent Recession Amid Suppressed Demand
- Published on
- 12 Mar 2020, 04:54 PM
By Sophia Rodrigues
Spending drives economic growth. So, less spending means less growth. A lot less spending could mean negative growth. Two quarters of negative growth means technical recession.
That in a nutshell is what the impact of coronavirus pandemic would be on Australia’s growth, and on the global economy.
Fiscal and monetary policy stimulus could provide boost to growth by encouraging spending but when the cause for spending is “suppressed” demand, the impact from any stimulus would be limited.
So, while welcome, the government’s fiscal stimulus package or the Reserve Bank of Australia’s monetary easing, are unlikely to prevent a recession this year. The only question is whether it will be two or three quarters of negative growth.
Earlier Thursday, Australia’s prime minister Scott Morrison and Treasurer Josh Frydenberg unveiled a stimulus package totalling A$17.6 billion that is expected to have an impact of A$22.9 billion on the economy over two years.
The package is far higher than what many economists expected a few days ago and as promised it is targeted.
LOST, SUPPRESSED, POTENTIAL, DEFERRED DEMAND
The main feature of the stimulus is the direct cash spending of A$11 billion until June this year that would support small businesses, income support recipients, and virus affected regions and communities.
This part of the stimulus has the potential to have stronger impact on the economy because it would put money in the hands of those who will spend it mainly on their day-to-day living, that is, the kind of spending one does to meet their basic needs. Some will need to spend all but others might be cautious and save for future, or they might be practising social distancing or their demand can simply not be met.
The latter two categories are what I would call “suppressed” demand. That’s the kind of demand that is either lost forever or goes into the category of “potential” or “deferred” demand. And this suppressed demand is not just from stimulus-recipients; it is from every Australian, irrespective of their spending capacity.
As long there is uncertainty about the pandemic, the potential or deferred demand would not turn into actual demand. The longer it lasts, the longer the impact will be on Australia’s growth. The more demand is lost forever, the deeper the impact on growth would be.
CONFIDENCE TO INVEST IMPORTANT
The support to businesses via asset write-offs and accelerated depreciation is a good stimulus measure. However, it works best during normal times, not when there is a global pandemic.
To save on tax and improve cashflow, a business must first invest in an asset. But to invest, a business must either be profitable currently and be confident that their business will continue to do well, or they must be confident that they can generate profits if they make additional investment. They also must have the cash or the capacity to borrow to fund it.
The extent of both, suppressed and lack of, demand in the economy is in a pandemic environment can be so huge that it is hard to see many businesses being confident of their outlook, let alone make decisions to make additional investment.
On the other hand, though, this is a very good incentive for businesses that are likely to be unaffected by the pandemic. For example, makers of toilet paper. If they use the tax incentive to replace an old machinery, it would be positive for the economy.
How positive such investment is for the economy also depends on whether the asset is imported or locally made. An imported asset would be demand “leakage” and the spending itself would provide very little benefit
But if this investment leads to more production and more employment, and more profits, then in the slightly longer term it would help Australia’s growth.