To cool inflation, the Federal Reserve is attempting a 'soft landing.' What is it, and will it work?
Russ Wiles, Arizona Republic
5 min read
After two years of yo-yo economic conditions, the Federal Reserve is trying to cool off inflation without tipping the nation into a recession. The buzz term for that is a “soft landing,” and that's the goal for the rest of this year, at least.
The tumult began with the flash-crash recession when the pandemic broke out in early 2020. Massive job losses ensued, followed by stimulus checks and Payroll Protection Program loans flowing everywhere. The stock market surged with all of that money floating around, Gross Domestic Product boomed, housing prices have gone through the roof in some markets, and jobs are more than plentiful.
The problem is that inflation has jumped as well, putting pressure on the central bank to tamp it down through a soft landing. Think of a jetliner hitting the tarmac smoothly, or at least with an impact no more jarring than a bump that causes a few bags to tumble from overhead bins.
Unfortunately for the economy, airline pilots have a lot more practice landing smoothly than the Federal Reserve, which now is striving to cool things off with a series of interest rate hikes that might not be enough or, conversely, might overshoot the runway.
If the Fed moves too slowly, it risks high inflation expectations embedding in the economy, making them more difficult to eliminate, wrote John Lynch, chief investment officer at Comerica Wealth Management. But if the Fed hikes rates too fast, "It risks tilting the economy into recession, with the associated job losses and other costs," he said in a commentary.
Is crimping inflation the main goal?
Yes. Inflation has surged, rising to an 8.3% rate nationally for the 12 months through April, down only slightly from 8.5% in March, a 40-year high. By comparison, in April 2020, two years earlier, consumer prices were increasing just 0.3% on average.
The economy usually runs in a low-inflation mode — the Consumer Price Index since 1960 has risen by about 3.8% annually. Persistently higher inflation can feed on itself and spark shortages and ever-escalating wages, erode personal wealth and, occasionally, lead to global unrest. Hitler’s rise to power was one consequence of Germany’s hyperinflation during the 1920s.
The U.S. isn’t anywhere near a hyperinflationary environment like that. If the Fed can throttle down into a soft landing, that could give consumers, especially in lower income groups, some relief. It also could bring the housing market back into equilibrium and result in a more normal employment market — not one where there are 11.5 million more job openings nationally than workers willing and able to fill them.
So the focus is on raising rates?
So far, yes, though the central bank eventually will need to reverse its quantitative easing strategy by pursuing a quantitative tightening program.
The easing strategy basically injected trillions of dollars into the economy by creating funds out of thin air and using them to purchase government bonds and other assets, to bolster liquidity in the wake of the 2020 recession. A tightening strategy would reverse that sequence, draining trillions of dollars from the economy, although likely much more gradually than they went in.
The Fed's strategy so far isn't to sell assets but to let maturing bonds "roll off its balance sheet," without investing proceeds in new bonds, said Lynch. At the current pace, quantitative tightening will take several years to complete, he predicted.
Have soft landings happened before?
Yes, as in 1994, noted Carl Tannenbaum, chief economist at Northern Trust. Back then, the Fed under Alan Greenspan started raising rates before inflation got out of hand. His strategy worked, inflation eased and the economy avoided a recession. But while the Fed got a lot of acclaim for its handling of the economy in 1994, “The outcome might have had more to do with luck than skill,” Tannenbaum recently observed.
For starters, in his view, U.S. demographics back then were more disinflationary in that workers from the giant baby boomer generation were passing through their most productive ages, with that productivity boosted by continual technological advancements. Immigration also was rising, adding to the productivity gains, he said.
Also, globalization was in full force with adoption of NAFTA, the North American Free Trade Agreement, and the opening of Eastern European economies after the fall of the Berlin Wall. Both factors “increased the availability of imports and facilitated the development of cross-border production,” Tannenberg wrote in a commentary.
Those conditions aren’t so apparent today, and inflation wasn’t out of control when the Fed made its moves, averaging 2.6% in 1994 following a 3% rise in 1993.
“The Greenspan Fed was the beneficiary of considerable good fortune, which the current Fed is unlikely to enjoy,” Tannenbaum concluded.
What could go wrong?
Plenty. If the Federal Reserve can’t execute a soft landing, a recession is one possibility. So is “stagflation,” a condition of persistently lofty inflation with little or no economic growth, possibly with substantially higher unemployment. It was a condition that characterized much of the 1970s. That's when the "misery index" gained popularity. It's a measure of distress that adds the unemployment rate to the inflation rate.
Many economists still think a soft landing is possible, though it won't be easy. “With some luck, the economy could maintain very low unemployment, slow economic growth and gradually declining inflation into 2023 and beyond,” wrote David Kelly, chief global strategist at JPMorgan Funds, in a recent commentary.
Kelly predicts financial markets could fare reasonably well if economic growth slows, especially given supply chain pressures of late. The economy, he reasons, has limited capacity currently to supply more goods and services, so “growth at any faster pace would likely keep inflation high and interest rates rising.”
But he cautions, “A lot still needs to go right for the economy to achieve this soft landing.”
