Will the Fed manage a ‘soft’ or ‘hard’ or ‘no’ landing?
THE US economy in 2021 turned in its best performance since 1984 as it emerged from the pandemic. But growth slowed markedly last year as the Federal Reserve jacked up interest rates to combat the fastest inflation in four decades.
Its aim: Cooling price pressures without driving the economy into a ditch. In 2022, housing slumped, manufacturing faltered – but the labour market remained strong. Economists, policy makers and investors are pondering what comes next: an economic soft landing, a hard landing or something in between. Or maybe even no landing at all.
1. What’s a soft landing?
It’s when a central bank slows the economy enough to curb demand and rein in inflation, but not so much as to trigger a contraction in gross domestic product and much, if any, rise in unemployment. It’s what Fed chair Jerome Powell and his colleagues ideally want to achieve. But doing so requires plenty of skill and a whole lot of luck.
2. What’s a hard landing?
In a word, recession. And it’s what many economists have forecast will happen as the Fed’s most aggressive credit tightening campaign since the 1980s takes an increasing toll on the economy. If what’s needed to squeeze inflation is extreme enough – or if the Fed makes a mistake – the labour market could finally crack, leading unemployment to rise significantly and millions of workers to lose their jobs. It’s not what Powell – nor for that matter Joe Biden, who’s all but certain to seek another term as US president in 2024 – want to see.
3. Isn’t there a middle ground?
Yes, it’s what some economists call a “growth recession”. This oxymoron refers to a protracted period of meagre growth and rising unemployment, where the economy expands more slowly than its roughly 1.5 to 2 per cent long-term trend, but an outright contraction is avoided. The aim is to slowly squeeze inflation out of the economy without collapsing demand and growth.
4. So what’s a no landing?
This is a term that began making the rounds at the start of 2023, as the economy started the year with a bang. Hiring surged, retail sales climbed and even homebuilders turned more optimistic. Under this scenario, growth reaccelerates after downshifting last year. In effect, the economy never really touches down.
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5. That sounds like a great outcome.
Yes and no. It all depends on what happens to inflation. While it peaked last year, it’s still well above the Fed’s official 2 per cent target. If it continues to fall as the economy revs up, that would be something to wish for. But if price pressures prove persistent – or even get worse – watch out. In that case, the Fed would probably feel compelled to ratchet interest rates ever higher, raising the risk of an even harder landing of the economy down the road.
6. Is the Fed really that committed to getting inflation back to 2 per cent?
Powell and his colleagues swear up and down that they are. And they insist they have no plans to increase their price target, despite calls from some economists to do so. But Powell & Co have also made clear that they’re willing to tolerate inflation above 2 per cent for a while, especially if it’s heading down. They’re not out to crash the economy just to bring inflation back to their goal.
7. Has the Fed ever accomplished a soft landing?
Arguably once, in 1994-1995. Under then-chair Alan Greenspan, the central bank doubled interest rates to 6 per cent 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.
8. 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 has suggested he thought that the Fed was on course for a soft landing as 2020 began. The US economy looked set to extend a record-long expansion after a series of rate moves. But then economic activity came to a halt due to the pandemic. BLOOMBERG
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