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The US Federal Reserve has a delicate task ahead of it: to rein in the economy so masterfully that it achieves what is called a “soft landing”.
Basically, the central bank is trying to dampen demand and control prices without tipping the economy into recession.
But repressing soaring inflation is already proving to be a difficult task. Top Fed policymakers later this week are expected to raise interest rates for the fourth time in five months. They moved more aggressively than expected at the start of the year.
Fed Chairman Jerome Powell recently suggested that a “soft” landing for the economy was possible.
But history suggests that achieving a perfect landing is easier said than done.
So what exactly is a soft landing?
Like a pilot gently landing an airplane, it takes a deft touch on the throttle to avoid an economical stall.
“The Fed slows the economy by raising interest rates, which reduces spending,” said Princeton economist Alan Blinder. “If you do too much, you’re going to have a recession.”
Blinder was Vice Chairman of the Federal Reserve in the 1990s, when the central bank engineered the perfect “soft landing.” Between 1994 and early 1995, the Fed raised its benchmark interest rate from 3% to 6%. Although economic growth slowed, GDP never declined and the job market remained strong, with unemployment actually falling.
What is the Fed’s record?
Often, however, the economy’s landing is bumpy.
“We’ve had 13 or 14 recessions since World War II, and more than two-thirds of those recessions have been caused by the Fed raising the interest rate faster than the economy can,” said University of Chicago economist Austan Goolsbee. Sunday weekend edition.
And many forecasters fear that, in its effort to control the current high inflation, the Fed could tip the economy into recession.
But Blinder is a bit more optimistic, using history as a guide. He took a close look at the 11 periods between 1965 and 2020 when the Fed raised interest rates. While the perfect soft landing only happened once, the economic fallout in six of the other cycles was limited with little or no decline in GDP and only a slight increase in unemployment.
“The moral of the story for me was, sweetish landings are not as rare as previously thought,” says Blinder.
Five more periods of rising interest rates were followed by severe recessions. But in three of those cases, Blinder argues, the central bank wasn’t even trying for a soft landing – including the draconian rate hikes under former Fed Chairman Paul Volcker in the late 1970s and early 1980s as he battled double-digit inflation.
Two other recessions were arguably unrelated to Fed actions, including the 2020 pandemic downturn.
“In addition to skill,” Blinder says, “you have to be lucky.”
What’s working against the Fed right now?
The Fed is facing severe crosswinds, which are making its task of reining in inflation more difficult. The pandemic combined with Russia’s invasion of Ukraine has caused severe supply disruptions, which are driving up prices.
Powell says he still sees a path to a soft landing. But he acknowledges that it is not entirely under the control of the central bank.
“It doesn’t get any easier,” Powell told reporters last month. “It becomes more difficult because of these external forces.”
Some unemployment may be tolerated by the economy, but painful for those who lose their jobs
One of the main strengths of the central bank is a strong labor market right now, so a slight increase in unemployment might be more tolerable than it would be under other circumstances.
Powell said if the cost of fighting inflation was a half-percentage-point rise in unemployment – from June’s rate of 3.6% to 4.1% – he would consider that a successful outcome and a soft landing.
“We’re not looking to put people out of work,” Powell said. “But we also think you really can’t have the kind of labor market that we want without price stability.”
Blinder agrees, noting that the unemployment rate soared above 10% during Volcker’s deliberate hard landing in the early 1980s.
“These are horrible unemployment rates,” Blinder says. “And I certainly don’t believe that Powell’s Fed, first of all, has to do anything like that or wants to do anything like that.”
Blinder warned, however, any rising unemployment is painful for those affected.
“For people losing their jobs,” he said, “it’s not sweet at all.”