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Will we dodge an economic slump? Maybe

Composite image showing pedestrians crossing the street in the rain and money, signifying inflation.
It seems assured that inflation will return to the RBA’s 2-3 per cent target band by late 2023. (Source: Getty) (Poppy Johnston)

The economy is overheating. Inflation is surging and the labour market is so strong that many firms cannot find the workers needed to open their doors each morning.

This is the legacy of the economic stimulus measures put in place when Australia slipped into a deep recession as the COVID pandemic impacted society in 2020 and 2021.

These policies were appropriate at the time but they need to be reversed.

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The recent data shows that with the economy expanding too rapidly, inflation is at a 30-year high and the unemployment rate is at a 48-year low - and it is set to fall further.

It is a rare and major economic problem but, thankfully, the solution to ‘too much economic growth’ is obvious and is slowly but surely being implemented.

Taking away the 2020 and 2021 stimulus measures are key to cooling the rate of growth and getting inflation under control.

Interest rate hikes and cuts to government spending and some tightening up on tax collections are vital policy changes.

While more will be done to take away the economic support measures, the policy changes taken so far to that effect are working.

Treasury and the Reserve Bank (RBA) have, in the past few weeks, released updated forecasts for the Australian economy.

At a macroeconomic management level, the outlook painted in these forecasts is about as good as it can get.

Based on the policy tightening - including globally - which will see the impetus to the Australian economy from overseas moderate, annual GDP growth is expected to slow from above 3 per cent at present to around 2 per cent in 2023 and into 2024.

This slowing in growth will see inflation moderate over that time and, while the forecasts are fluid, especially in light of the trends unfolding in commodities markets and the global economy, it seems assured that inflation will return to the RBA’s 2-3 per cent target band by late 2023.

At the same time, the unemployment rate will remain near historical lows – at 4 per cent or less over the whole forecast horizon.

It is a scenario any treasurer or Reserve Bank governor would embrace wholeheartedly.

And while it is clearly premature to seriously consider the economic outlook beyond late 2023 or 2024, that is the time when business and policy makers should be pencilling in a scenario for an economic pick up.

Until then, the policy-management issues are firmly set on delivering slower economic growth and, with that, lower inflation.

Labor's huge budget challenge

To date, the focus has been on the RBA and its interest-rate-hiking cycle.

But now, attention is and should be on the new Labor Government’s approach to fiscal policy and how it can tweak its spending and taxing policies to help get inflation under control.

Treasurer Jim Chalmers will deliver his Budget on October 25, which will outline Labor’s plans for the economy.

There are many reasons why the Budget should include a mix of government spending cuts and tax increases.

Containing inflation is one.

The other is repairing the budget which, on the latest figures, has deficits each year for the next decade and rising government debt.

These are not sustainable and the best time to repair the budget is when the economy is strong and overheating – like now.

It remains to be seen what measures Chalmers will deliver, especially given the size of the budget problem he has inherited.

With annual budget deficits hovering around $50 billion, or more, getting back to balance or even a moderate surplus is a huge challenge.

It will be important for monetary and fiscal policy to work together to unwind the COVID stimulus and return policy settings towards a more normal setting.

Done well, as the latest official forecasts show, it will ensure inflation slows and set the economy up for the next expansion phase in the years ahead.

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