‘What if?’ and low probability economic scenarios for Australia

Oksana Patron

20 December 2022

The Actuaries Institute has modelled alternative economic scenarios of “low probability, high impact” for Australia, assuming stagflation, mismanaging a collapse in house prices and adoption by policymakers of Modern Monetary Theory.

In its Green Paper “The Long Run: Low probability, high impact scenarios for the Australian economy and financial markets” the Institute discussed plausible scenarios involving a significant recession within the next 15 years which might put policymakers, advisers and industry on alert at all times.

The first of the three alternative scenarios assumed the chance of stagflation, combining high inflation with high unemployment, which would see expansionary fiscal policy, too loose monetary policy and supply side constraints combined and would lead to a wage-price spiral, with inflation peaking at around 9%.

The eventual solution would include high unemployment and high long-term government bond yields.

The second scenario would be a major correction in house prices, based on a 30% drop in dwelling prices which was beyond all current mainstream projections.

In this scenario, the price decline would be triggered by an overly aggressive Reserve Bank tightening cycle leading to a cascading effect across the economy and financial markets.

According to the paper, the interest in this scenario was refreshed by the current slowdown in the housing market, high levels of household debt, budget pressures, stagnant wages growth, bank exposures to housing and rising interest rates.

The final alternative scenario assumed an adoption of Modern Monetary Theory focusing on achieving full employment by funding government expenditure through creating money rather than issuing debt.

The paper said this was a “new paradigm” scenario and although full adoption was unlikely policymakers moved some way in that direction, with the activity benefits of the MMT-driven boom largely evaporating during the subsequent recession.

Actuaries Institute president, Annette King, said actuaries regularly considered the long-term outlook for the Australian economy and financial markets as part of their professional work for many different industries.

“Scenario analysis is widely used by government, regulators and businesses. It has wide application across all sectors of the economy and allows the impact of myriad factors to be assessed, such as climate change, cyber and pandemic risks – key challenges all organisations are currently facing,” she said.