Date posted: 27/03/2020 5 min read

We’re headed for recession but how far will we sink?

A key difference between the predicted recession and those of the past is this one hasn’t been caused by an economic shock.

In Brief

  • A recession is inevitable due to the COVID-19 shutdowns, but how bad it will be remains to be seen.
  • The economic bounce-back is more likely to be a U shape than a V, but could be longer and shallower.
  • The Australian economy was already a little fragile before the crisis hit, with a weak private sector.

By Christopher Niesche

Governments, businesses and economists have all acknowledged Australia, New Zealand and the rest of the world is headed for a recession, but the questions remain, how deep will it be and what will the recovery look like?

The technical definition of a recession is two quarters of negative growth. Independent economist Saul Eslake expects they will be big negatives, worse than other recessions in Australia over the past few decades.

The 1991 recession involved three quarters of negative growth with a cumulative decline of about 1.5% of Australia’s GDP and the recession of 1982-83 lasted for about four quarters for a total contraction of 2.25%.

Eslake expects a contraction in the coming recession of 3% or 4%.

However, he doesn’t expect unemployment to rise as sharply as it did in those previous recessions or to continue to rise even after the economy starts to recover – in the most recent recession unemployment rose to about 11% in 1993 – because the Australian government is focused on preserving jobs rather than trying to avert a downturn.

The bounce-back

A key difference between this recession and others is that it hasn’t been caused by an economic shock, but by the public health measures introduced to contain the coronavirus.

There is potential for the economy to bounce back quite quickly once the health crisis has passed. “It depends on how quickly governments feel that they can relax the restrictions that they've had to impose and how much damage has been done to the sustainability of employers and businesses in the meantime,” Eslake says.

However, Alex Joiner, chief economist at IFM Investors, says the Australian economy was already “a bit fragile” when the crisis hit and this might make for a longer and shallower recovery.

While on the face of it, 2.2% economic growth in the 12 months to December last year may not appear too weak, Joiner says “if you scratch beneath the surface of those numbers, what you see is a pretty weak private sector”.

Much of the growth is explained by government spending and government investing, while the small business sector in particular was weak.

He too expects the current recession to be “quite deep, despite the best efforts of policymakers”.

Will it be a ‘U’ or a ‘V’ recovery?

As for recovery, Joiner expects a ‘U’ rather than a ‘V’. That means instead of the economy dipping quickly and bouncing back in the shape of a V, it will fall and remain weak for some time as he expects people will only gradually get back to their normal activities.

He also expects some activity to be lost entirely to the economy by being cancelled – such as the AFL season in Australia – rather than being deferred until the crisis has passed.

Brendan Rynne, chief economist at KPMG Australia, says it’s impossible to know how long the crisis will last because of the unknowability of the two variables that will determine its duration – the level of infection in the community and when the health crisis will end, either with the introduction of a vaccine or via mass infection leading to herd immunity.

Another big difficulty is that there is no financial model that reflects what happens when an economy is turned off and then turned back on, which is likely to be the effect of the public health measures.

“There is no financial model that reflects what happens when an economy is turned off and then turned back on.”

“That's what we're potentially dealing with at the moment,” Rynne says.

While a V-shaped decline and recovery such as occurred after SARS in 2003 was anticipated at the start of the current crisis, “that’s now unlikely to be the case,” says Rynne.

The current crisis “has the potential to drag on”, he says.

However, like Joiner, he expects a longer and much shallower recovery, which is what happened in the wake of the Spanish Flu epidemic a century ago.

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