What would tip the Australian economy into a recession we ‘don’t have to have’? | Saul Eslake

The Reserve Bank of Australia has acknowledged that its recent five interest rate hikes could make the economy feel like it's in a recession. Major companies like Qantas, Canva, and the National Australia Bank have announced significant job cuts. While there's no strict definition of a recession, it's often seen as two or more consecutive quarters of negative growth in real GDP.

However, a better indicator, called the Sahm rule, would trigger a recession if the three-month moving average of the unemployment rate increases by half a percentage point or more relative to its lowest point in the previous 12 months. Reserve Bank staffers believe this rule should be applied if the unemployment rate rises by three-quarters of a percentage point compared to its low over the past year.

If the unemployment rate follows the average increase from the past six months, a recession might be imminent by next January. The AI bubble, if it bursts, and the RBA overdoing monetary policy tightening could also trigger a recession. The RBA may have tightened monetary policy too much between 2022 and 2024, leading to a post-policymaking recession.

The RBA doesn't view higher unemployment as a solution for inflation, as it's just a side-effect of the cure - slower growth in demand. The federal government should aim to reduce the risk of the RBA raising interest rates excessively by ensuring a smaller budget deficit for 2026-27 than 2025-26. This could be achieved by raising additional revenue or cutting government spending, either public or private.