The Treasurer is set to release the 2026 Intergenerational Report (IGR) on Monday, mapping out how the Budget is expected to evolve over the next 40 years. But what the IGR’s business-as-usual projection misses is the impact of crises – like the COVID-19 pandemic – that erupt overnight rather than build slowly over decades.
Major shocks like these have shaped Australia’s past fiscal trajectory, and they won’t stop coming. In forthcoming e61 research, we model the impact of 3 plausible future crises, each large enough to knock the Budget off the course the IGR maps out in its central scenario. This modelling raises a question that the IGR does not ask: will the Budget have enough room to absorb one or more such shocks in the future?
The IGR’s framework means it doesn’t see shocks coming
The IGR presents economic projections for the next 40 years, based primarily on how the Treasurer and Treasury believe Australia’s population, participation and productivity will evolve. This is a useful framework to think about the forces that shape business-as-usual growth and the structural pressures building over time.
But, as former UK Prime Minister, Harold Macmillan, supposedly said, it’s “events, my dear boy, events” that blow governments off course – not the slow-burning trends they can see coming, and plan for in documents like the IGR. Australia has experienced a few events – the COVID-19 pandemic, the GFC and the 1990s recession each required the government of the day to marshal economic resources and take on public debt to shield Australians from the financial and physical harms of the shock.
Upcoming e61 research will model the impact that 3 of these kinds of shocks could have – events large enough to require a government response well beyond the business-as-usual case captured in the IGR. These are stylised examples intended to highlight the potential impact of future crises on the federal Budget, not projections of what is going to happen.
Three examples of shocks that could knock Australia off course
Heightened global economic and geopolitical uncertainty means that we need to consider a wider range of shocks than just the economic downturns of the past.
Indeed, the 2023 IGR acknowledges the importance of elevated geopolitical risks – but does not model any possible crises that stem from these risks, instead providing little more than a qualitative discussion (see Box 1.2, 2023 IGR).
One of the scenarios analysed in my research is the possibility of a major geopolitical crisis that causes a substantial reversal in global cooperation and trade, such as a significant escalation in trade and military conflict in the Asia-Pacific region. This could involve events such as import/export restrictions, disruptions to shipping lanes and supply chains, through to military conflict.
In addition to the non-economic harms, this would trigger a deep recession in Australia and across the world. This recession would be driven by a collapse in demand for Australian exports, a sharp deterioration in the terms of trade, supply-chain disruption, higher global risk premia and tighter financial conditions.
Another potential crisis stems from a global bond market shock following a loss of confidence in the United States’ ability to service its debts and the subsequent loss of their reserve currency status. This would rapidly increase the cost of debt for both the Australian Government and private sector borrowers.
Such a bond market crisis would almost certainly trigger a global economic downturn and cause a severe recession in Australia. The direct effects of higher borrowing costs are comparatively minor compared with the likely recession, which would reduce tax revenue and increase spending on support payments and fiscal transfers.
A final scenario considered in this research is a severe domestic recession, along the lines of a scenario that is already used by the banking regulator, APRA, to stress test the Australian banking system. This scenario is characterised by a collapse in external demand, falling commodity prices and a global confidence shock that spills into the domestic economy.
The next graph shows how these 3 modelled shocks compare to recent crises in terms of their impact on the federal Budget’s underlying cash balance. The domestic recession and bond market crises may produce a government response of similar magnitude to previous recessions like COVID-19, peaking between 3-6 per cent of GDP. In contrast, the response to the geopolitical crisis peaks around 18 per cent of GDP – but this is a uniquely severe scenario and it is improbable that this fully reflects the policy response, which is likely to be more substantial and drawn out than anything that the world has experienced in the post-WW2 era.
These 3 scenarios are also highly correlated.
A bond market crisis could coincide with a geopolitical flare-up. A conflict in the Asia-Pacific could trigger a loss of confidence in US Treasuries. Each of these would likely trigger a deep recession.
Layered on top of these potential discrete crises is the slow-burn of climate change. As the 2023 IGR outlined, higher average temperatures, more extreme weather events and natural disasters will increase government spending on disaster response.
This will result in an ongoing cost through more spending on climate mitigation and adaptation – such as building sea walls and adapting public spaces for more hot days. But there will also be larger spikes in disaster recovery payments and rebuilding costs when these more frequent and large disasters strike.
But it is important not to treat this as a prediction of how things will play out
No one can forecast the exact fiscal cost of future crises, and this work does not claim to do so. This modelling is intended to help build a better appreciation of the magnitude of the risks that the Australian economy faces, and whether a federal government has the fiscal breathing room to respond.
The importance of shocks to the Budget bottom line does not mean the IGR does not have tremendous value in showing how underlying demographic trends like population ageing have on the Budget. Thinking about the future is more important, not less, when we are less sure about what the future looks like.
In a way, the IGR’s projections should be seen as laying the foundation for how much space a federal government will have to respond to future shocks under current settings, while the scenarios discussed in my work tell us how much of this fiscal buffer would be required if things are no longer business-as-usual.
Aaron Wong is a senior research economist at e61 Institute. His research focuses on the intersection of labour and urban economics, using micro data to understand how location shapes the decisions made by Australians on where to live and work.
Aaron previously worked at the Reserve Bank of Australia, where he analysed Australia’s housing markets, contributed to economic forecasts and examined financial risk to the RBA’s domestic portfolio.
He holds a Bachelor of Economics (Honours) and Bachelor of Commerce from the University of New South Wales where he graduated with First Class Honours and the University Medal in Economics.