The Fed's mission improbable: Beating inflation without causing a recession
The U.S. Federal Reserve has a delicate job in front of it — pumping the brakes on the economy in such a masterful way that it achieves what is known as a "soft landing."
Basically, the central bank is trying to curb demand and bring prices under control without tipping the economy into recession.
But cracking down on sky-high inflation is already turning out to be a tough task. The Fed's top policymakers later this week are expected to raise interest rates for the fourth time in five months. They have moved more aggressively than expected at the beginning of the year.
Fed chair Jerome Powell has recently suggested that a "softish" landing for the economy is possible.
But history suggests achieving that 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 economic stall.
"The Fed slows the economy down by raising interest rates, which cuts spending," says Princeton economist Alan Blinder. "If you do too much of that, you're going to get a recession."
Blinder was vice chairman at 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%. While economic growth did slow down, GDP never shrank and the job market remained strong, with unemployment actually declining.
What's the Fed's track record?
Oftentimes, however, the landing for the economy is bumpy.
"We've had 13 or 14 recessions since World War II, and more than two-thirds of those recessions were caused by the Fed raising the interest rate faster than the economy can handle," University of Chicago economist Austan Goolsbee told Weekend Edition Sunday.
And many forecasters worry that in its effort to control today's high inflation, the Fed could tip the economy into recession.
But Blinder is somewhat more optimistic, using history as a guide. He's looked closely at the 11 periods between 1965 and 2020 in which the Fed raised interest rates. While the perfect soft landing happened only once, the economic fallout in six of the other cycles was limited with little or no decline in GDP and only a modest rise in unemployment.
"The moral of the story to me was, soft ish landings are not as rare as was thought," Blinder says.
Five other periods of interest rate hikes 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 '80s when he was wrestling with inflation in the double digits.
Two other recessions were arguably unrelated to the Fed's actions, including the pandemic downturn of 2020.
"In addition to skill," Blinder says, "you need to be lucky."
What's working against the Fed right now?
The Fed is facing some severe crosswinds, which make its job of curbing inflation more difficult. The pandemic combined with Russia's invasion of Ukraine have caused severe supply disruptions, which are driving up prices.
Powell says he still sees a path to a soft landing. But he acknowledges, it's not entirely under the central bank's control.
"It's not getting easier," Powell told reporters last month. "It's getting more challenging because of these external forces."
Some unemployment can be tolerated by the economy, but painful for those that lose jobs
One of the main things the central bank has going for it is a strong job market currently, so a modest uptick in unemployment might be more tolerable than it would under other circumstances.
Powell has said if the cost of curbing inflation is a half-percentage point increase in unemployment — from June's rate of 3.6% to 4.1% — he would consider that a successful outcome, and a softish landing.
"We don't seek to put people out of work," Powell said. "But we also think that you really cannot have the kind of labor market we want without price stability."
Blinder agrees, noting that the unemployment rate soared above 10% during Volcker's deliberately hard landing of the early 1980s.
"Those are kind of horrific unemployment rates," Blinder says. "And I certainly don't believe that the Powell Fed, first of all, has to do anything like that or wants to do anything like that."
Blinder cautioned, however, any increase in unemployment is painful for the people affected.
"To the people that lose their jobs," he said, "this is not soft at all."
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AYESHA RASCOE, HOST:
Inflation, as we know, is sky high. The Federal Reserve hopes to bring it back down to earth by raising interest rates. But there's a possible downside. Here's how economist Austan Goolsbee put it on this program last week.
(SOUNDBITE OF ARCHIVED NPR BROADCAST)
AUSTAN GOOLSBEE: You know, we've had 13 or 14 recessions since World War II, and more than two-thirds of those recessions were caused by the Fed raising the interest rate faster than the economy can handle.
RASCOE: So what are the chances that the Fed can curb inflation without crashing the U.S. economy? We're going to talk through that now with NPR chief economics correspondent Scott Horsley. Hi, Scott.
SCOTT HORSLEY, BYLINE: Great to be with you, Ayesha.
RASCOE: So we keep hearing about how the Fed wants to engineer a soft landing. What does that mean?
HORSLEY: It means slowing down the economy so we don't have these runaway price hikes, but doing so in a controlled way so you don't stall the economy and end up in a recession. Ideally, as the Fed raises interest rates, spending will gradually slow down, supply gets to catch up with demand, inflation cools off. But you need a careful hand on the throttle so you don't wind up in a crash.
RASCOE: What is the central bank's track record when it comes to being able to pull this off?
HORSLEY: In the last five decades, there's really only been one perfectly soft landing. That was in the mid-1990s. Alan Blinder, who was vice chair of the Fed at the time, has made a study of this. He says there are actually a half-dozen other times since 1965 when the Fed managed to pull off what he calls a softish landing - that is, they raised rates with little or no decline in the GDP and only a modest increase in unemployment.
ALAN BLINDER: The moral of the story to me was softish landings are not as rare as was thought.
HORSLEY: In fact, since the mid-'60s, Blinder says, the Fed's managed to achieve a softish landing a little over half the time.
RASCOE: So what happened those other times when they didn't manage to do the softish landing?
HORSLEY: Yeah, sometimes they weren't even trying. You know, in the late 1970s, for example, inflation had been way too high for way too long. Then Fed Chairman Paul Volcker basically slammed the brakes on the economy, triggered a deep recession. It worked in the sense that it did bring inflation under control, but at a very steep cost. Unemployment soared above 10%. Blinder says there were two other recessions that followed a period of interest rate hikes that weren't really caused by the Fed's moves. Most recently, for example, in 2020, we had a deep recession, but it wasn't the Fed's fault. It was caused by the pandemic. So Blinder says to avoid that takes both skill at the Fed and some good luck.
RASCOE: So how is the Fed's luck so far? Like, are they having some headwinds or some tailwinds?
HORSLEY: Some of both, actually. There are definitely challenges that are making the Fed's job harder, including ongoing pandemic lockdowns in China, lingering supply disruptions, of course, the war in Ukraine, which has sharply driven up the price of energy and food. On the plus side, though, the central bank does have a couple of things going for it. Even though inflation is very high right now, it hasn't been high for all that long, so it's not baked into people's expectations the way it was back in the 1970s. That helps.
Also, we are approaching this landing with a really strong labor market. So even if the landing is bumpier than we'd like, it's unlikely we'll see anything like the double-digit unemployment that people suffered through in the early 1980s. Fed Chairman Jerome Powell said last month if unemployment were to tick up by, say, half a percentage point as the price of getting inflation under control, he would consider that a successful outcome. And Blinder agrees with a caveat.
BLINDER: To the people that lose their jobs, this is not soft at all.
HORSLEY: The Fed is expected to boost interest rates again later this week, so put your seat back and tray table up and buckle in.
RASCOE: That's NPR chief economics correspondent Scott Horsley. Scott, thank you so much.
HORSLEY: You're welcome. Transcript provided by NPR, Copyright NPR.