Interest rate cuts won't be enough to stave off a recession

The economy is in effect highly indexed, meaning it is designed to compensate just about every significant group from the impact of inflation. A large fall in the value of the dollar will create serious inflation, and if this is passed through to income recipients, including welfare recipients, our double-digit cost disequilibrium will not be reduced much, if at all, by a falling dollar.

But a falling dollar will mean the RBA will have to modify or suspend its inflation target, with possibly severe consequences for its credibility. This is already strained by its relatively sanguine "glass half full" rhetoric, just as Treasury (and therefore the government) has been far too optimistic in its predictions about both the economy and its assumed return to surplus.

One hopes Treasury's initial briefing for the incoming Treasurer has been more realistic about Australia's economic conditions and prospects than those parroted by Swan, and also that Treasury has told Chris Bowen what it thinks should be done.

Henry's view is that Australia cannot now avoid a recession and that in what I call a "realistic worst case" it will be a recession of at least the severity of those in the early 1980s and the early 90s, with double-digit unemployment even on the Australian Bureau of Statistics definition.

With unchanged policies, the budget deficit will blow out severely and budget tightening will be forced on Australia by global market vigilantes, whether we like it or not.

Claims that the coming recession will be caused by "mindless austerity" of an Abbott government, should the election be won by the Coalition, are simply hogwash. In the unlikely case of an election win by Rudd Labor, or another hung parliament, most politicians will be gobsmacked by the state of the economy and the national budget.

Cutting interest rates further may somewhat reduce distress, but will do nothing to relieve the cost disequilibrium, and may indeed worsen it. Only focused action by a fully informed and highly competent government can hope to steer Australia through the strong recessionary currents we are experiencing.