The GFC and COVID-19 shocks occurred suddenly, leaving Australia’s net debt permanently higher. Now, with environmental and geopolitical risks rising, how much fiscal room does the federal budget need to absorb the next blow?
This research note stress tests the budget against 3 severe but plausible crises alongside the rising cost of climate-driven disasters. The fiscal effects are modelled using the Parliamentary Budget Office’s Build Your Own Budget tool.
The analysis finds that:
- A geopolitical crisis is the biggest threat, potentially worsening the budget balance by around 18 per cent of GDP at its peak and 46 per cent over a decade – and as a highly unlikely event with difficult-to-quantify consequences, the true response would likely be larger than modelled.
- A deep recession or bond market breakdown carries a large fiscal cost with effects peaking in the range of 3–6 per cent of GDP, comparable to past shocks like the GFC and COVID-19.
- The budget’s primary buffer isn’t designed for shocks. The Contingency Reserve’s Conservative Bias Allowance is designed to manage routine program overruns, not economy-wide downturns.
- Climate change adds an ongoing cost of around $5 billion a year in disaster recovery payments – yet the budget makes no provision for disasters that haven’t happened yet.
- The cost of risk. Weighted by likelihood, these geopolitical and financial risks cost around 0.8 per cent of GDP a year.
These risks are also correlated. A bond market crisis could coincide with a geopolitical one and either would likely bring a deep recession.
The current budget arrangements aren’t built for shocks of this size. This note also discusses the trade-offs of 4 distinct options to build more fiscal headroom, including budget rules, a larger Contingency Reserve, dedicated reserve funds and an independent fiscal council.
