(Bloomberg) -- US policymakers led by Federal Reserve Chair Jerome Powell have been trying since early 2022 to use higher interest rates to ease price pressures without causing the economy to contract — an ideal scenario that economists call a “soft landing.” While history suggested that would be almost impossible to pull off, as inflation fell and economic output grew economists inside and outside the Fed became increasingly convinced that policymakers might manage it this time. But a sudden sagging in job numbers released in early August and global market turmoil that followed had some wondering if the Fed might feel pressured to cut interest rates more aggressively than it had planned, to protect against a harder-than-expected landing.
1. What’s a soft landing?
It’s when a central bank is able to slow the economy enough to curb demand and bring inflation closer to its target — 2% in the Fed’s case — but not so much as to cause a significant downturn and a big 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 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 US 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, for his part, has spoken of the possibility of a “softish landing” for the economy — a scenario where unemployment rises but not by all that much while inflation comes down and the economy keeps growing, albeit feebly. That would be what some economists call a “growth recession.”
4. Could the Fed pull off a soft landing this time?
The odds are that it will, though a quickly moderating labor market poses risks. The economic data tell the story: Consumer price inflation fell to 3.0% in June 2024 from a high of 9.1% in June 2022. The job market has softened some, with the unemployment rate rising to 4.3% in July, though that’s still historically low despite the Fed’s most aggressive credit-tightening campaign in decades. Fed economists last year rescinded their forecast of a mild recession. Private economists also revised their views, with economists in a July Bloomberg survey putting odds of the US entering a recession in the next 12 months at 30%. Still, following recent cooling in jobs, Goldman Sachs economists increased the probability of a US recession in the next year to 25% from 15%.
5. So is it clear sailing from here?
Not quite. After a strong 2023, growth and the labor market are slowing markedly, making the economy more susceptible to outside shocks, such as a potential widening of war in the Middle East. What’s more, the impact of the Fed’s recent interest rate increases has yet to be fully felt. Households that drew down their savings to keep buying as inflation raged are now having to pay punishingly high interest rates on their credit card balances. Companies, too, are facing substantially higher borrowing costs as debt taken out during the pandemic comes up for repayment. While Powell himself has indicated that he’s increasingly confident a soft landing is likely, he told reporters July 31 “of course the job is never done. We’re watching to see which way the economy heads.”
6. What’s Powell’s strategy now?
He’s been cautiously teeing up interest rate cuts for September and beyond — too cautiously in the view of some on Wall Street, who are pricing in larger cuts amid expected economic weakness. The idea is to lower rates in tandem with the decline in inflation, and thus provide the economy with some support without reigniting price pressures. The market jitters that followed release of July job numbers, including a decline in US and global stocks, could complicate his mission, with some investors calling for the Fed to take emergency action to lower rates now rather than wait for September.
7. Does the Fed do things like that?
Rarely, and not in the way that those making such calls are proposing. During Powell’s tenure as chair, the Federal Open Market Committee, the central bank’s policymaking body, has only used super-sized moves during emergencies. In the first two weeks of March 2020, it cut its benchmark rate by 1.5 percentage points to rapidly reach zero as Covid-19 began slamming the US economy. In 2022, the FOMC raised rates in both 50- and 75-basis-point steps in the face of steeply escalating inflation.
Large moves have signaling effects that communicate an emergency or aggressive response. To many Fed-watching economists, the July labor market data didn’t rise to a level of imminent threat that has caused the committee to make such big moves in the past. Additionally, Fed officials frequently comment that they do not respond to a single economic report and instead base policies on trends that develop over many months.
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