This seminar analyses the origins of the COVID-19 economic downturn in Australia and the appropriateness of the fiscal policy response. In the COVID-19 economic downturn, weakness in economic activity has largely matched government suppression of the supply of certain consumer services, leading to unusual V-shaped downturns and recoveries in GDP. The appropriate fiscal response is to compensate factors of production in the suppressed industries for their losses of income while the suppression is in place.

The actual fiscal response has included JobKeeper, accelerated depreciation of new investment, and lump sum payments to businesses, all of which are temporary. The first version of JobKeeper involved three forms of over-compensation, two of which were addressed when JobKeeper was extended. The fiscal response also includes some more long-lasting measures.

This actual fiscal response is incorporated in the baseline scenario of a macro-econometric model. The automatic stabilisers scenario shows that, without the fiscal response, the economic downturn in 2020 would have been far more severe. The preferred scenario shows that, by curtailing some longer-lived parts of the fiscal response, a rebound in inflation in 2022-2023 could be avoided. The lessons for the future are to ensure that the fiscal response lasts only as long as the government suppression of economic activity, and that it is more carefully designed to avoid overcompensation.