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The Australian economy faces the greatest series of financial risks in decades, as the odds of a global recession continue to increase. The crisis in Ukraine, the energy crisis in Europe and Australia, the after-effects of COVID-related measures, and continued disruptions to global supply chains are darkening the economic outlook. Inflation expectations are being reset and interest rates are rising, with market expectations of future interest rates well beyond official forecasts.

Victoria has the largest state budget deficit in the nation and the largest state government debt level in absolute terms and as a share of the economy. Victoria also has the highest level of taxation as a share of the economy, the fastest growing state government spending rate as a share of the economy in the nation, the fastest growing public sector wages in the nation, as well as the fastest growing public sector workforce on mainland Australia.

Victoria’s debt exposure is particularly of concern at a time when rising interest rates will lead to significant increases in the costs of servicing the debt. Every extra dollar needed for debt servicing will be at the expense of alternative and productive uses. Conversely, if the Victorian government does not address the budget deficit and the rising debt levels, Victoria could face a debt trap in which even more drastic action is required.

This paper demonstrates that the Victorian economy is particularly vulnerable to the economic shocks that are coming its way, because of the growth in the size of the state and the dramatic increase in the public sector wage roll, financed in part by increased taxes and asset sales, but also by a massive increase in the level of debt.

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