Australia must be ready to pump cash into the economy if Brexit bites

Australia must be ready to pump cash into the economy if Brexit bites

27 June 2016

By Stephen Koukoulas

Brexit is important for Australian policymakers. Whichever side wins the 2 July federal election will need to have policy pragmatism to deal with the potential fallout.

With the British people electing to permanently destroy their wealth, incomes and living standards by voting to leave the European Union, global economic risks have intensified. One only has to witness the savage reaction in financial markets as it became apparent the “Leave” vote was winning.

There were several trillion dollars of value lost to global stock markets, the yield on government bonds fell to never-before-seen levels and currency markets went into meltdown, with the British pound dropping more than 10% to reach its lowest level since 1985.

Australia will not be immune from the fallout from the Brexit vote. Like the experience throughout the world, Australian share prices have already fallen sharply and government bond yields have dropped to historic lows. While it is clearly early days for markets, commodity prices have also dropped sharply. For the already fragile nature of the domestic economy, Brexit is presenting very real downside risks.

For policymakers and the markets, some effects from the Brexit vote will be obvious. The Reserve Bank of Australia will need to continue its strategy of cutting interest rates, and the Australian dollar is likely to fall as it acts as a safely valve to cushion Australia from weaker global growth and low commodity prices.

That is the easy part of the analysis.

The role for fiscal policy is unclear. Whichever side wins the 2 July election, the news is probably stark. The so-called incoming government briefing documents from Treasury and the Department of Finance will deliver some unwelcome news on those risks to the economy and budget. For the term of the current Coalitiongovernment, nothing has been done to improve the structural position of the budget.

The Treasury frustration is palpable. The desirability of “reloading”the budget to give a war chest of funds to fight any future global economic risks has been an issue that Treasury hounded former treasurer Joe Hockey and then his successor, Scott Morrison, to address. Alas, nothing was done.

Yet in the months and years ahead, there may be a need to consider fiscal stimulus if some of the worst-case scenarios from Brexit come to pass. A Brexit-inspired crisis would open a legitimate debate concerning the budget deficit versus protecting economic growth. As was evident during the banking and financial crisis in 2008 and 2009, the shrewd, pragmatic and well-targeted use of fiscal policy stimulus from the government saw the economy avoid recession and capped the unemployment rate at a remarkably low 5.9%.

It was a masterclass of policy that saw Labor treasurer Wayne Swan awarded Euromoney magazine’s world’s best treasurer prize in 2011. It also saw Fitch Ratings upgrade Australia’s credit rating to AAA, which meant for the first time ever, Australia had the coveted top credit rating with a stable outlook from all three major credit rating agencies.

The fiscal stimulus also extended the period the Australian economy had gone without a recession. Now, Australia can boast that it has been 25 years since the last recession, a feat without precedent.

Australian policymakers should be on standby to use fiscal policy as the fallout from Brexit becomes clearer, with the aim an extension of the 25 years without recession.

There must be doubts about the ability of a returned Coalition government to do the right thing, given it opposed some of the stimulus measures during the GFC and has argued in more recent years that a return to budget surplus is a policy priority regardless of the state of the business cycle.

We have seen what misguided fiscal policy has meant for countries in the Eurozone – a deeper recession and higher unemployment.

It is to be hoped that if the fallout from Brexit causes global economic dislocation, Australian policymakers will follow the policy approach used during the GFC and not stick with a crazed obsession with the budget balance.

Stephen Koukoulas is a Research Fellow at Per Capita, a progressive thinktank.

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