Federal budget 2023: Only ‘one in two’ chance to avoid recession, says RBA

Reserve Bank analysis from September last year predicted there was only a one-in-two chance the central bank would be able to bring inflation under control without triggering a recession.

Treasurer Jim Chalmers during question time on Thursday. Picture: NCA NewsWire / Martin Ollman

Reserve Bank analysis from September last year predicted there was only a one-in-two chance the central bank would be able to bring inflation under control without triggering a recession.

In emails dated September 27 and released on Thursday under Freedom of Information laws, an unnamed RBA economist wrote: “Like peer countries, Australia is in the midst of a historically rapid monetary policy tightening cycle in response to high inflation.”

The cash rate at the time was 2.35 per cent. It is 3.85 per cent today.

“Financial market commentators expect these rate rises to ­induce recessions in some economies. While the general view among private sector economists and financial markets is that recession in Australia is unlikely, it is nonetheless an important question to explore analytically,” the economist wrote.

The RBA’s macroeconomic model – known as MARTIN – was used to assess the likelihood of various scenarios and con­cluded “there is a one-in-two chance Australia ends up on the ‘narrow path’ – where inflation ­returns to target without requiring a recession”.

Using an alternative approach that was not tied to the RBA’s central forecasts and which therefore allowed a “more flexible approach for exploring recession probabilities”, the analyst found that “the probability of a recession over the next two years could be as high as 80 per cent”.

“If a recession does occur, it is most likely sometime over the next four quarters. This is in line with intensifying market commentary predicting a recession in the first half of 2023,” the economist wrote.

This more dire forecast ­appears dated given the ongoing strength of the economy though the first half of this year.

CBA head of Australian economics Gareth Aird played down the significance of what he ­believed would be regular internal modelling exercises.

He said the high projected likelihood of recession “highlights that you’ve got to take these models with a pinch of salt, especially at a time like now when so many unusual things are going on”.

The RBA has more recently ­assumed a peak cash rate of 3.75 per cent in its forecasts – ­essentially at the current level of 3.85 per cent – and has said that this is consistent with returning inflation to the top of the 2-3 per cent target range by mid-2025, which governor Philip Lowe has deemed an acceptable time frame if it means preserving the employment gains made through the pandemic.

Separate analysis from February, titled “alternative monetary policy paths”, estimated a more aggressive New Zealand-style rate path peaking at just over 5 per cent would bring inflation below 3 per cent by the end of 2024, but drive unemployment towards 5 per cent, from 3.5 per cent now.

The analysis comes after Jim Chalmers revealed he had spoken to Dr Lowe before delivering his second budget as he continued to defend the government against arguments $21bn in extra spending would keep interest rates higher for longer.

The Treasurer said it would “actually be negligent if I didn’t do that”, adding that he spoke regularly to Dr Lowe about Labor policies and the fiscal stance of the government, while repeating his argument that the budget delivered cost-of-living relief without adding to inflation.

Dr Chalmers rejected the idea interest rates would be higher for longer as a result of the extra spending in the budget, despite a series of leading forecasters delaying their time frame for a rate cut following Tuesday’s budget.

“What the economists, what the Treasury are saying, is that at worst the budget is broadly ­neutral over that period, but you see in the inflation forecast that the energy relief plan, for example, is taking three quarters of a percentage point off the inflation forecast in the coming year,” he told ABC radio.

Responding to the warning by Westpac chief economist Bill Evans that he believed rates relief would now be delayed to beyond February next year, Dr Chalmers said: “The point that he’s making is that the budget doesn’t put upward pressure on interest rates.”