Can Australia avoid a recession like we did during the GFC?

With inflation potentially peaking, interest rates rising, and economic activity slowing after its post-pandemic high, many people think that Australia’s financial situation is looking bleak. So much so, there’s been speculation that if we don’t play our cards right, we could fall into a recession.

A technical recession counts as two consecutive quarters of negative gross domestic product (GDP) growth. Australia briefly fell into recession in 2020, when we experienced two quarters of negative growth during the COVID-19 pandemic. Before that, the last time Australia came close to recession was the Global Financial Crisis (GFC). But can we use the same strategies to get through the current cost of living crisis unscathed?

The GFC in a nutshell

The GFC took place during 2007 to 2009, and saw many countries slip into recession. But how did it happen in the first place? Here’s a quick summary:

• US housing market crash: House prices in the US peaked in the middle of 2006 but began to plummet soon after. The catalyst for the GFC was these falling US house prices combined with a rising number of borrowers unable to repay their loans.
• Stresses in the financial system: Roughly one year later, in mid 2007, some lenders and investors began to incur large losses because many of the houses they repossessed could only be sold for less than the loan balance. Investors also became reluctant to purchase mortgage-backed securities (MBS) products and were actively trying to sell their holdings.
• Spillovers to other countries: Since foreign banks were active participants in the US housing market during the boom, including purchasing MBS, and US banks had substantial operations in other countries, there was a channel for the problems in the US housing market to spread - and that, it did.
• Failure of financial firms, panic in financial markets: Financial stresses peaked after the US investment bank Lehman Brothers filed for bankruptcy in September 2008 (the largest bankruptcy in US history). Together with other financial firms failing or on the brink of collapse, this triggered a panic in financial markets globally. 

How Australia dealt with the GFC

The GFC was an undoubtedly traumatic financial event, causing uncertainty across the globe. But under the circumstances, Australia fared relatively well. 

During the GFC, Australia only had one quarter of negative GDP growth - December 2008, contracting by 0.5% - so while we came close, we never reached technical recession status.

Australia’s relatively strong performance during the GFC came from a range of factors:

•   Australian banks had very small exposure to the US housing market and banks, partly because domestic lending was very profitable.
•   Subprime and other high-risk loans were only a small share of lending in Australia, partly because of the historical focus on lending standards by the Australian banking regulator, the Australian Prudential Regulation Authority (APRA).
•   Australia's economy was buoyed by large resource exports to China, whose economy rebounded quickly after the initial GFC shock.

Even with a few things in our favour, it wasn’t an easy battle for Australia to avoid a recession. The nation enacted a large policy response to ensure that the economy didn’t suffer a major downturn. Specifically, we undertook an expansionary fiscal policy and provided guarantees on deposits at, and bonds issued by, Australian banks.

As part of their response, the government introduced stimulus packages, which were a key strategy in getting the economy back on track. These included cash payments, the trebling of the First Home Owners Grant, a 50% temporary investment allowance, and a $15 billion school modernisation plan. These measures were designed to spread stimulus across multiple industries and to stagger its effect across 2009-2010 to keep the economy out of a recession.

The Reserve Bank of Australia (RBA) also jumped into action, increasing the cash rate on four different occasions to try and bring high inflation back into balance. 

Ultimately, these responses worked, with Australia successfully escaping a recession.

What is the current economic climate?

Now, Australia is faced with a new financial crisis - this time, a cost-of-living crisis. The Consumer Price Index (CPI) indicates Australia’s level of inflation, and as of the December 2022 quarter, annual CPI rose to 7.8%. That’s why essentials like groceries, petrol and housing are going up, while savings are going down - to the alarm of many Australians.

This high inflation comes off the back of very different causes to the GFC:

Repercussions of the COVID-19 pandemic

While the pandemic had profound public health implications, it also caused a major economic contraction. To help keep the economy afloat, the government offered a range of support and stimulus measures, including JobKeeper, Coronavirus Supplement, and Economic Support Payments, while the RBA slashed rates to record lows. 

However, this cheaper access to money may have led to many Australians building up extra savings during lockdowns, which they are only now able to spend, pushing up the demand side of inflation. Additionally, stimulating the building industry may have contributed to a backlog of construction projects and ongoing shortages of materials and labour, raising the cost of building and buying new dwellings. 

The Russian invasion of Ukraine

War in Europe leads to loss of life, political tension, global insecurity and economic instability. Oil supplies are limited and demand has increased, resulting in the biggest annual rise in prices since 1990.

Increasing climate volatility

Whether due to the impacts of the Queensland floods on transport and supply, or increased input costs, this meant the price of groceries were more expensive, leading to all food and non-food grocery products seeing an increase in prices.

Corporate profits

The RBA has also been pointing towards a potential “wage-price spiral” as a risk factor for rising inflation and a cause for hiking the cash rate. However, a recent study by the Australian Institute indicated that Australia's rising inflation levels may be being influenced by a ‘profit-price spiral’, where corporate profits may be making things worse than wage growth. 

How can Australia avoid another recession?

During the GFC, Australia used careful financial and economic management to avoid falling into a recession. But the current cost of living crisis has different origins, and may require different tools to manage. 

For example, the government stimulus used during the GFC may not be an effective solution to the current crisis, as too much stimulus during the pandemic may have contributed to the current rising inflation.

The Federal Treasurer is confident that Australia will avoid a recession, while acknowledging the difficulties affecting everyday Australians. Factors such as a lift in overseas tourism and an influx of international students into Australian universities could potentially help to maintain enough economic growth to avoid recession.

The RBA’s main tool for tackling inflation is to raise the national cash rate, which it has already done multiple times since April 2022, in one of the most aggressive monetary tightening cycles in its history. When you lift interest rates on credit products, consumers and businesses are less likely to borrow funds to increase their spending capacity. Additionally, any person or entity that has borrowed will have to pay more to service their debt decreasing their ability to spend in other areas. When spending decreases, the theory is that this can slow down economic growth and inflation.

However, raising rates too hard and too fast could risk putting too much pressure on Australian household budgets. If higher interest rates were to lead to large numbers of Australians being forced to sell their home or default on their loans, the scales could be tipped further towards recession.

The RBA is in a difficult position, having repeatedly talked about walking a “narrow path” towards a “soft landing”. The target goal for the RBA is to get the annual rate of inflation down to between 2 and 3%. With inflation having possibly peaked near 8%, homeowners will be crossing their fingers that rising rates help to curb inflation sooner rather than later. The RBA has indicated that it could pause its rate hikes soon, though this will depend on other economic indicators.

Of course, this doesn’t address the supply-side factors affecting inflation. Resolving these issues may require further intervention from local and international governments, as well as the business community. For example, meaningful climate action could help to better manage the risk of future natural disasters and their impact on the economy.

What can individual Australians do about a recession?

Whether Australia is headed for a recession or not, taking a few simple steps today could help you be well prepared for whatever is coming tomorrow. Some of these steps may include:

• Assess your budget: To start with, get a better understanding of how your money is coming and going, on a monthly and annual basis.
• Pay down debts: If you have a mortgage, a car loan, or a credit card, you may want to consider putting more money towards lowering these debts while you can. This may help to reduce the interest you’re charged down the track.
• Add to your emergency fund: Keeping some money in reserve can help to ease the burden of unexpected expenses, like home or car repairs, or help you stay afloat if you were to lose your job.
• Switch and save: Whether you reach out to your mortgage lender to negotiate a discount, refinance your loans with another lender, or consolidate your debts, options are available to help you manage your debts.
• Get help when you need it: Consider contacting an expert for more advice, such as a mortgage broker, accountant, or financial adviser. If you find yourself in financial stress, free financial counselling services are also available.

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