U.S. policymakers led by Federal Reserve Chair Jerome Powell have been trying since early 2022 to use higher interest rates to ease price pressures without causing the economy to contract — an ideal scenario that economists call a “soft landing.” History suggests that’s almost impossible to pull off. But with inflation falling and economic output growing, economists inside and outside the Fed are increasingly betting that policymakers might pull it off this time.
1. What’s a soft landing?
It’s when a central bank is able to slow the economy enough to curb demand and bring inflation closer to its target — 2% in the Fed’s case — but not so much as to cause a significant downturn and a big rise in unemployment. Doing that takes a combination of smart policy making and luck.
2. Has the Fed ever accomplished this?
Arguably once, in 1994-1995. Under Chair Alan Greenspan, the central bank doubled interest rates to 6% and succeeded in slowing economic growth without killing it off. The tighter credit did have adverse consequences, though. It led to huge losses for bond market investors and contributed to the 1994 bankruptcy of Orange County, California. Mexico was also compelled to seek a bailout from the US and the International Monetary Fund.
3. Has every other attempt been a failure?
Not quite. Alan Blinder, who was Fed vice chair for the 1994-95 soft landing, says the central bank has achieved some other “pretty soft” landings during the past half-century. One came in 2001, when Fed rate increases that began two years earlier brought about an exceedingly mild, eight-month downturn — what Blinder calls a “recessionette.” Powell, for his part, has spoken of the possibility of a “softish landing” for the economy — a scenario where unemployment rises but not by all that much while inflation comes down and the economy keeps growing, albeit feebly. That would be what some economists call a “growth recession.”
4. Could the Fed pull off a soft landing this time?
The odds that it will are growing. The economic data tell the story: While consumer price inflation ticked up to 3.7% in August because of higher gasoline costs, it was still well below the 9.1% peak seen in June 2022. The job market has remained solid, with unemployment not far off a multidecade low, despite the Fed’s most aggressive credit-tightening campaign in decades. That’s led Fed economists to rescind their forecast of a mild recession. Private economists are also rethinking their views, with a strong majority saying that the odds of the US entering a recession in the next 12 months are 50% or lower, according to a National Association for Business Economics survey.
5. That’s good news for President Joe Biden, isn’t it?
It sure is. If the US did suffer a recession next year, Republicans could be counted on to fault Biden for mishandling the economy as he seeks to win another four-year term as president in November 2024. If instead an economic downturn is avoided and price pressures continue to ease, Biden could then claim credit for corralling inflation. Indeed, one of Biden’s premier economic policymakers, Treasury Secretary Janet Yellen, said in an interview on Sept. 10 that she was increasingly confident that the US would be able to contain inflation without major damage to the job market.
6. So is it clear sailing from here?
Far from it. Yes, inflation has fallen a lot. But much of the decline reflects an unwinding of price pressures arising out of the Covid-19 pandemic and Russia’s invasion of Ukraine. Lowering inflation over the so-called last mile to the Fed’s 2% target is likely to prove more difficult, economists say. That’s because the fastest inflation is in the services sector, where prices tend to be stickier and where wages account for a bigger share of the costs of running a business. Powell himself has warned that taming inflation will probably require some rise in unemployment, though he’s betting that the increase will be modest and that a recession will be avoided.
6. What’s Powell’s strategy now?
He’s feeling his way cautiously. After the Fed raised rates in July for the 11th time in less than two years, Powell studiously avoided giving the public a clear steer on what might come next, saying that a lot will depend on how the economy evolves in the coming months.
This article was provided by Bloomberg News.