I am especially wary of economists — that includes Federal Reserve members and well as former Fed members — who are quick to see a soft landing for the U.S. economy.
Soft landings are rare. Former Fed Vice Chair Alan Blinder, in a Wall Street Journal opinion article last year, went so far as to reclassify the 1969-70 recession (which he claims he has always viewed as a “recessionette”) as a soft landing. This is instructive. Because this re-labeling of the 1969-70 recession as a soft landing looks a lot more like stagflation to me. I
The role of recession
No one wants a recession. But in our current state of understanding, the way we reduce inflation is to reduce aggregate demand. That is what a recession does. If we could spur output in the short run, then a pro-growth, supply-side response that lifted supply/output faster as demand hit constraints in fact might be an option. But, sadly, our state of knowledge and ability does not permit such a strategy. When demand pushes constraints, and prices rise, the solution is to damp demand and put recession front and center.
Because consumer spending is some 70% of U.S. GDP, it is hard to reduce aggregate demand without causing recession. There is no way to reduce demand that does not spread effects that risk a broadening impact. This is why demand reduction and recession go hand-in-hand.
The Fed’s current tactic, promoted loudly recently by Fed Vice Chair Lael Brainard, is a curious strategy. December 2022 CPI rose 6.4% year-on-year, the core CPI rose at a 5.7% pace. The December Fed meeting raised the Fed funds rate to 4.25% to 4.5% (call it 4 3/8%). That means the Fed funds rate is still below the inflation rate. With a 0.25% bump, the range goes to 4.5% to 4.75% — still below the inflation rate. Is that enough?
Policy that depends on kindness
The sense that yes, this is enough, means that Fed policy will depend on the kindness of strangers. Since the Fed funds rate currently is not above inflation, the Fed’s view will continue to be that inflation is going to fall by itself.
When inflation has been this far out of control, I do not see this as an aggressive remedy. This is more like the halfway, what-the-heck policy that that got us into this mess in the first place. I would think after making such an egregious error on inflation, the Fed would be more determined to make sure it is reducing inflation than to sit back and let economic forces, that they project to exist, do the job.
The main problem with this is that Fed forecasts have not done very well. From 2015-2018 the Fed undershot its inflation target while raising rates steadily. It’s reasonable to ask why did the Fed persistently raise rates if inflation was too low? Then, amid the COVID pandemic, the Fed joined the stimulus party with the Federal government. In big, broad terms this may seem right, but government health policy was impeding growth. Businesses were shuttered. People were being told to stay at home. What was the point in lowering rates at that time?
Fiscal stimulus was excessive, but it was an income replacement program. It was poorly crafted, badly administered and too large, but Fed policy was simply wrong. The Fed’s stimulus lasted too long as the central bank denied inflation as it appeared and lagged in rate hiking.
So Brainard’s view is to hope (forecast) that inflation falls enough on its own that a Fed funds rate at 4.5% or maybe 5% will become high-enough above inflation to be able to suppress it. But, how quickly will this lower inflation to 2%? This slow grind may prevent recession, or lead to a modest one, but it likely will lead to an extended period of high rates, since inflation will not easily fall to 2%. That begins to look like stagflation to me.
Bad is good
The Fed denied inflation, letting it run hot though 2021 and in early 2022. In March 2022 the Fed finally acted. But by that time the Fed’s hopes that inflation would be temporary were smashed by a run of strong monthly inflation gains. For example, the PCE headline rose by 0.5% in December 2021, by 0.5% in January 2022, by 0.6% in February and by 1% in March as the Fed finally hiked rates.
Upcoming months will see those strong headline inflation gains excised from the record. The Fed’s bad news then becomes its good news. This may be why Fed members are so willing to boldly call for letting Fed funds rates go flat, because they realize that the pipeline of past inflation is going to disgorge a string of truly unruly numbers.
The odds of new monthly figures being lower than the dropped rates are quite good, but not assured. To get inflation to 2% will require a monthly gain of 0.1% coupled with two gains of 0.2% every quarter. While recent inflation news has been much improved, it has not been that good, and there are growing concerns that oil prices will move higher. On balance there is good news coming from history, but we still can’t quite depend on the new inflation gains to be as well-behaved as the target demands.
Mild recessions as soft landings?
That brings us to Blinder’s view that 1969-70 was a soft landing, and what precedent that might set should that be a model for a soft landing. In 1966, PCE inflation (headline and core) was below 2%. By the end of that year it had crept above 2%; the core level then was at 3%. In 1967, the PCE climbed to 4% and was at 4.5% by the time the recession began in December 1969.
Although the Fed reversed course to cut rates in the recession, inflation did not come down in the recession. It stayed at 4.5% (headline) to 5% (core) until 1971 then it fell to as low as 3% by September of 1972 before moving sharply higher in 1973. The unemployment rate rose by 2.6 percentage points in this recession.
If that’s a soft landing I don’t want to see another like it. There is nothing soft here and there is no landing for inflation. The rise in the unemployment rate, even a moderate one, is a cost borne for no offsetting benefit. Of course, this segues into the 1973-75 recession, another recession that ended without bringing down the inflation rate. The 1969-70 recession was a gateway to an inferno of inflation. I would never suggest it as a model for economic policy, as Blinder does by calling it a soft landing.
So we have to be careful about the language we use to describe the economy. First of all, there is no precise definition of a soft landing, which makes it a dangerous term. To me, soft landing implies that there has been a landing. That should mean some phase of policy adjustment has been completed and is no longer needed. This suggests that at the landing, the economy is on a path to grow normally with inflation at its target pace. The “soft” part implies that policy got us there without much disruption.
That, of course, is vague and not defined in terms of negative growth or changes in the rate of unemployment — it’s a judgement call. The Fed wants to achieve inflation reduction by forecast instead of by policy. That usually does not work.
Robert Brusca is chief economist at FAO Economics.