The global economy is in recession

By: Glenn Stevens Governor
Address to the Australian Institute of Company Directors
Directors Luncheon
Adelaide – 21 April 2009

The global economy is in recession. Virtually all of Australia’s trading partners are contracting. In fact almost every country with which we would normally make comparisons is in recession, and for many of them it is a bad one.

It is very rare for Australia to escape an international downturn and there is no precedent for avoiding one of this size. We, like most countries, have trade and financial linkages to the rest of the world. We are all aware of what happens abroad, and our own expectations and economic behaviour cannot but be affected by those events. Whether or not the next GDP statistic, due in early June, shows another decline, I think the reasonable person, looking at all the information available now, would come to the conclusion that the Australian economy, too, is in recession.

These are periods of hardship for significant parts of the community. People lose jobs, businesses fail, loans go bad, and plans are unfulfilled. As such, they are to be avoided if possible and at least ameliorated when they occur. It is for the latter reason that most countries today have extensive social safety nets, so that when recessions do occur, we can avoid the extent of outright misery seen in episodes like the 1930s.

Policy makers also seek to cushion such downturns with macroeconomic policy. They are usually more successful if they have managed to restrain the preceding boom. But no country’s policy makers have been able to eliminate the business cycle, much as they have all tried. Cyclical behaviour has always been a feature of market economies. It always will be. Should you see, at some future time, a claim to the contrary, it would be advisable to treat it with great scepticism and, indeed, as a possible indication that a cyclical turning point is in the offing.

Most of the time, economic activity expands, as population growth, increasing wealth and aspirations to higher living standards lead to more demand, while a growing workforce, higher productivity and technological innovation push up supply capacity. That is the normal situation for an economy.

But every so often – on average about once every seven or eight years, but not regularly enough to predict with accuracy – a set of conditions arise that see demand weaken for a while, output decline and unemployment rise. That is a recession. Usually, though not always, inflation tends to fall as a result of such episodes.

Modern Australia has experienced a number of recessions – in the early 1950s, the early 1960s, the mid 1970s, the early 1980s, the early 1990s, and now in 2008/09. There were also events that could reasonably be labelled brief recessions in 1957 and 1977. On that count, the current episode will be the eighth recession since World War II. Most of these events have been associated with international business cycles.

There were significant mid?cycle slowdowns, which did not develop into recessions, in the mid 1960s and very early 1970s2, the mid 1980s, the mid 1990s and 2000/01. In each of these periods, output slowed or even fell very briefly, the rate of unemployment stopped falling and/or rose, and inflation moderated.

The 2000/01 episode was notable in that it coincided with a downturn in the major countries. It was very unusual for Australia not to have a recession in such circumstances, though as it was, the rate of unemployment rose by about a percentage point in the space of a year. One aspect that helped us on that occasion was that the downturn in many of the major countries was not an especially deep one. Another was the continuing strength in some other key trading partners, not least China. This time, the state of the global economy is much worse.

The extent of that weakness was unexpected. Until the financial crisis escalated so dramatically last September, it appeared that some of the major countries would have downturns, but that the emerging world, including Asia, would not slow as much as on some other occasions. Although affected by weaker demand from the industrialised world, many of these countries appeared largely to be free both of the financial problems in the major countries and of the sorts of problems they themselves had experienced in past episodes. The growth of China seemed to be on a strong medium term path, albeit with a cycle like every other economy. This was not ‘de?coupling’, simply the assessment that the net of competing forces would produce a significant slowdown, but not a slump. Hence, global growth was generally expected to slow to below average, after several years in which it had been unsustainably high.

Then, things took a serious turn for the worse. The financial turmoil following the Lehman collapse was the most intense in generations. It was contained within about six weeks, and indeed over the past few months conditions have been gradually improving in financial markets, in several respects. But we are now seeing the fallout in the rest of the economy from that financial turmoil. The weakened ability of the financial institutions to provide credit to industry is one of the factors at work, but in my judgment a bigger one is the decline in confidence, and the sudden and widespread aversion to risk, among firms and households all over the world. It seems that everyone, everywhere, having seen the instability in financial systems in September and October 2008, and consequently feeling poorer and fearing bad times ahead, simultaneously decided to pull back their own spending, curtail their expansion plans and reduce their debt.

It was, of course, entirely rational, at the individual level, for firms and households to behave in a more precautionary way. But the collective sum of those decisions created, over the ensuing six months, an international slump in demand for consumer durables and investment goods that was sharper, and more synchronised, than any seen for decades. The result is that the world’s gross product is now thought likely to decline in 2009, the first time that has happened for many decades.

Australians shared in this more cautious behaviour, particularly in the business world. A range of business surveys indicate that a trend moderation in business confidence that had been occurring for some months turned abruptly much weaker in October, and remained weak thereafter. There was some recovery in March. (The behaviour of Australian household confidence surveys has not been as weak, as I shall come to later.) While official data are yet to show it, it is likely that business investment spending is in the process of declining sharply. Hiring intentions have been scaled back quickly. Residential investment and exports have fallen.

Source: RBA: Speech-The Road to Recovery