May you live in interesting times

The turbulent events of the previous year — and the economic and political decisions made to cope with them — are bound to shape the course of 2023, writes AICD chief economist Mark Thirlwell MAICD.

The world keeps reminding us that prediction is a fool’s errand. Attempts to forecast the global economy since 2019 have been derailed by shocks ranging from COVID-19 to Russia’s invasion of Ukraine. Last year was a particularly tumultuous one — war, pandemic, inflation, market meltdowns and the biggest global energy shock since the 1970s all buffeted the international economy to such an extent that analysts adopted the idea of a “polycrisis” to capture this sequence of overlapping and compounding crises.

One obvious lesson is that we can’t forecast what 2023 will have in store with any confidence. Yet, because many of the developments set in motion during that tumultuous 2022 will play a crucial role in 2023, we can at least identify some of the forces shaping the year ahead. Globally, for example, shockwaves from the Ukraine conflict, the inflationary surge and the most synchronised round of international monetary policy tightening in decades will continue to reverberate. Hence, the future trajectories of the war, inflation and global monetary policy, as led by the US Federal Reserve, will all be critical. Likewise, although China’s battle with the pandemic appeared to move on to a new phase late last year, the legacies of its 2022 lockdowns and public unrest, as well as the preceding property market mayhem, will persist, influencing Beijing’s policy choices.

Meanwhile, back in Australia

The same logic applies to Australia’s economic outlook. Perhaps most obviously, prospects will be driven by the Reserve Bank’s ongoing quest for a soft landing — returning inflation to target while avoiding a recession. By the end of last year, Martin Place had already implemented 300bp of interest rate increases over the course of eight board meetings — and warned that more were to come. Lags in the monetary policy transmission process mean the consequences of this rapid shift to tighten policy will be felt more keenly in 2023 than they were in 2022.

If the RBA gets its calibration right, if inflation is not too “sticky” and if any further unhelpful shocks are absent, interest rates should peak later this year as the economy slows and inflation starts to moderate. If the RBA gets it wrong, triggering a recession, then monetary policy could end up moving into reverse by year’s end.

Meanwhile, that policy balancing act will keep attention on the central bank through 2023. An intriguing subplot is that the RBA review, announced by the Treasurer last July, is scheduled to report in March. Conditional both on the recommendations and on how the government chooses to respond, there could be profound implications for the future of Australian monetary policy.

Budget blues

Another key development from last year was the May 2022 federal election and subsequent change of government. One consequence was that 2022 saw not one, but two budgets, with October’s version the first from a new government since 2014. Budget 2022: The Sequel was constrained firstly by the need to avoid setting fiscal policy in direct opposition to the RBA’s inflation-fighting agenda, and secondly by the presence of a persistent gap between government payments and receipts. As noted in last December’s column, the budget’s contribution was largely to detail the problem created by previous administrations’ inability to match tax receipts with public expenditure levels into the future. Ideally, this year’s budget should propose some solutions. But to do so credibly, the Treasurer will have to make a big call on which budget levers to pull — additional expenditure restraint to drag spending down towards receipts, or new tax increases to better match revenues with public expectations regarding current and projected public expenditure? Given that context, a rerun of last year’s debate over the stage three tax cuts beckons.

Of course, when it comes to budget repair, the preferred option of most governments is neither lowering spending nor increasing taxes, but rather lifting economic growth. With the short-term macro policy levers focused on inflation and not activity — that leaves structural reform. Here, the new government has brought with it changes in both style and substance.

For example, it has introduced a new approach to industrial relations reform, with a focus on lifting wage growth. Following the October 2022 Jobs Summit, that ambition brought legislation intended to restore the waning attractiveness of enterprise bargaining and — more controversially — to promote multi- employer bargaining as a way of tilting the balance of labour market power.

Productivity and power

A second example of this shifting policy focus comes from a series of 2022 speeches from Assistant Minister for Competition, Charities and Treasury Andrew Leigh, arguing that Australia has a market power problem, characterised by too much concentration, too little competition and not enough dynamism. In this context, another review launched last year was then Treasurer Josh Frydenberg’s tasking of the Productivity Commission to undertake its second five-yearly evaluation of national productivity performance. The commission’s report is due this February and it will be useful to gauge the extent to which it aligns with the current government’s priorities.

Yet another potentially significant carryover from last year is the state of the bilateral relationship with China. The year 2022 brought a notable shift in tone following the federal election, and 2023 could test whether this can lead to anything more substantial, given what remains a deeply challenging geopolitical and geo-economic environment.

Finally, there is the increasingly important energy-climate change nexus. As last year drew to a close, the government was announcing measures in response to high energy prices including temporary caps for wholesale gas and coal prices, along with targeted financial relief for vulnerable households. Their initial impact — and any associated political fallout and pushback from energy companies — will be felt this year. At the same time, pressure on the government to successfully roll out its promised Powering Australia plan — including the expensive task of updating the electricity grid — will grow. Canberra will also have to pursue its pledges to meet Australian emissions targets and stand ready to deal with any further fallout from climate-related extreme weather events. And then there will be whatever new challenges that the rest of this year holds in store.