(Bloomberg) —
Federal Reserve Chair Jerome Powell and his colleagues are embarking on a delicate task: They’re trying to use higher interest rates to bring down sky-high inflation without crashing the U.S. into a recession. The ideal result would be what economists call “a soft landing.” Steering the U.S. economy toward one has been made immeasurably harder by Russia’s invasion of Ukraine and the aftershocks that’s triggered in global energy, commodity and financial markets.
1. What’s a soft landing?
In short, it describes the Fed’s main job these days: Slow the economy enough to curb demand and rein in decades-high inflation, but not so much as to trigger a contraction in gross domestic product and a 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 then-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 U.S. 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 has suggested he thought that the Fed was on course for a soft landing in 2020, when the U.S. 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.
4. What are the Fed’s chances this time?
Powell told lawmakers in early March that he believes achieving a soft landing is “more likely than not.” Some prominent economists are not so sure. Former Fed Governor Lawrence Lindsey puts the odds of an economic downturn by the end of next year at above 50% — triggered by a meltdown on Wall Street as the Fed raises the cost of credit. Ex-Treasury Secretary and paid Bloomberg TV contributor Lawrence Summers says the risk of a recession sometime before the 2024 presidential election “is certainly 50%.”
5. Why the gloom?
The skeptics argue that the Fed waited too long to address mounting price pressures by insisting for months that those inflationary forces would prove to be “transitory.” Now the Fed has to play catch-up and may feel compelled to jack up interest rates so much to combat inflation that it will inadvertently trigger a recession.
6. Why was the Fed slow off the mark?
It was partly by design. After years of falling short of its 2% inflation target, the Fed adopted a new monetary regime in August 2020 under which it forswore taking preemptive action against inflation. Instead, it promised not to lift rates from near zero until inflation had hit 2% — and was poised to exceed that level moderately for some time – and the economy had returned to full employment. Now, with inflation well above the Fed’s objective — and the labor market “at least” at maximum employment, by Powell’s own admission — he’s catching flak from all sides. At a Senate Banking Committee hearing on March 3, Alabama Republican Richard Shelby and Nevada Democrat Catherine Cortez Masto pushed him to admit the Fed had flubbed it by not being quicker to tackle rising prices. In a rare admission for a Fed chair, Powell said that “hindsight says we should have moved earlier.”
7. What is Powell’s strategy now?
He’s betting that a judicious tightening of monetary policy, combined with an easing of supply-chain bottlenecks and the winding down of the federal government’s pandemic-relief programs, will help rein in inflation without upending the economic expansion. With the financial implications of Russia’s attack on Ukraine “highly uncertain,” he’s said the Fed at first would proceed especially carefully in withdrawing the support it is providing the economy. But he’s made clear that the central bank is prepared to act more aggressively if inflation doesn’t come down as expected.
The Reference Shelf
- Bloomberg QuickTake explainer on why measuring inflation is such tricky business and one on the Fed unwinding its balance sheet.
- A 1995 research paper by economist Edward Yardeni says economic busts often are the result of central bank policy-engineering to correct failures in managing booms.
- Former Fed Chairman Alan Greenspan recounts his 2000 soft-landing miss in his book, “Age of Turbulence.”
- The International Monetary Fund’s guide to how central banks tame inflation through inflation targeting.