This opinion piece was first published on Stuff on 26 June 2023.

In any “normal” economic cycle, the instigation of a recession by the Reserve Bank would represent a failure to meet its remit, which includes directives to “support maximum sustainable employment” and “avoid unnecessary instability in output”. Put simply, if the Reserve Bank sees a recession coming, its usual response should be to cut interest rates to cushion the downturn, limit the rise in unemployment, and prevent deflationary pressures building if businesses come under intense pressure.

But this is not a normal economic cycle. Forecasts of economic apocalypse due to the global COVID-19 outbreak in 2020 led to a policy response of record low interest rates and massive government spending. When it became apparent that expectations of the downturn had been overcooked, it proved much more difficult to reverse this stimulus than it had been to put it in place.

More on the role of monetary policy in a moment. But it’s worthwhile highlighting the exceptional growth in government consumption spending over the last three years. Comparing our pre-COVID forecasts with subsequent outcomes reveals that household spending is roughly in line with what we were expecting in early 2020, but government consumption spending is 14% larger than anticipated. Government support for the economy was necessary during lockdown, but households are now paying the price for the government’s inability to cut its spending from higher pandemic-era levels now that we’re out the other side.

Usually when a slowdown looms on the horizon, the economy is in a position of rough balance but, instead, the economy’s starting point this time around has been incredibly overheated. The most obvious symptoms of this overheating have been an unemployment rate as low as 3.2% and inflation at a 32-year high of 7.2%pa. So instead of cushioning the downturn, the Reserve Bank’s primary goal at the moment is to weaken demand. By doing so, cost and price pressures will be reduced, enabling the Bank to achieve its primary mandate: returning inflation to within its 1-3%pa target band.

Some economists have concluded from the news of recession that the Reserve Bank has “done too much”. But this diagnosis completely misses the economy’s overheated starting point, as well as the mix of strong and weak indicators still coming through in the data.

Because the Reserve Bank failed to anticipate inflation’s acceleration during 2021 and 2022, it has understandably wanted to be sure that it is getting inflation back under control before ending its tightening programme. It has only been the last couple of months that any good evidence of things starting to turn has come through. Data showing an unexpected slowing in inflation to below 7%pa was published in April, and the Reserve Bank’s survey in May showed a considerable moderation in inflation expectations over the next two years.

Even so, the indicators have not universally pointed towards a downturn. Filled job numbers have increased 2.4% over the first four months of this year, the fastest growth since 2004/05, and unemployment has so far stayed stubbornly low. Accelerating wage growth has become an increasingly important driver of cost pressures across the economy.

On the demand side, higher prices have been squeezing household spending volumes, but continued growth in the value of spending suggests that higher interest rates aren’t sucking as much money out of the system as the anecdotes tell us. Even the 0.8% contraction in GDP over the last six months looks modest compared to the 3.0% growth recorded during the previous six-month period.

There’s undoubtedly more of a squeeze to come for households over the next six months as existing mortgages come up for refixing at higher interest rates. Businesses are also likely to lose much of their appetite for additional workers. However, most of the expected lift in unemployment over the next year will arise from job growth not keeping pace with population growth, rather than widespread redundancies.

The idea that unemployment is being pushed up at all is seen as unfair by some people, and it’s important to recognise the uneven distributional effects of the emerging downturn. People who lose their job will obviously be hit hardest. High inflation is being felt most acutely by lower-income people whose budgets are already tight, with little discretionary spending to pare back. And much higher mortgage rates are a major issue for people who borrowed heavily to get into the housing market in 2020 and 2021.

Is it too much? No forecaster is predicting the unemployment rate to get over 5.5% during 2024 or 2025, well below the 6.6% reached in 2009 following the Global Financial Crisis, so it looks like a relatively soft landing. The more important question is whether households should be bearing the cost of rectifying the economic imbalances, if the government is unwilling to moderate its borrowing and spending behaviour.