Quit worrying about the’soft landing’ that the Federal Reserve is planning.
The Federal Reserve’s ability to achieve the much-touted “soft landing,” or bringing inflation down to its 2% objective without triggering a recession, is a topic of great discussion at the moment. Quite challenging.
Those who are always worried about inflation are especially worried about the so-called “last mile” of reducing inflation, which they say could necessitate more stringent measures than previous ones. The real federal-funds rate is expected to rise as inflation declines, according to growth skeptics. They also worry that a hard landing could result from the Fed’s intransigence in maintaining a nominal federal-funds rate of 5.5% for an extended period of time.
It appears like almost everyone is oblivious to the fact that the Fed has already accomplished a soft landing in this discussion. We are firmly planted on the earth, yet anything could happen later.
Begin by completing the “landing” portion at 2%. The FOMC, led by Chairman Jerome Powell, wants to wait for a few more months of extremely low inflation before they declare success and begin cutting interest rates. It’s a fair stance to take.
Take a look at the latest figures for inflation, though. The deflator for personal-consumption expenditures, the chosen measure of inflation by the Fed, shows that the 12-month inflation rate has dropped from 7.1% in June 2022 to 2.6% currently. Well on my way. The 4% annualized inflation rate from the first quarter of 2023 is factored into that 2.6% rate, but it will be removed from the calculation in a few months. Now, the PCE inflation rate, when adjusted for the preceding six months, is about 2%. A little over zero is the annualized rate of inflation for the past three months, in case you were curious. There’s a clear decline there.
The performance improves considerably further when we move to the “soft” component. An unexpectedly strong 3.1% expansion occurred in the American economy in 2023. It is noteworthy that the unemployment rate has remained at or below 4% for 25 months running. Net new jobs created over that time amounted to about eight million, or 317,000 each month on average.
The lauded “perfect” soft landing that occurred in 1994–1995 occurred when I was serving as vice chairman of the Federal Reserve. Taking into account its origins and subsequent events, the Fed’s accomplishments this time around are more remarkable.
Things didn’t appear to be going well when the Federal Reserve started tightening in March 2022. To begin, the FOMC was running behind schedule. One possible explanation is that actual growth was negative during the first half of 2022. Federal Reserve officials were afraid of exacerbating an already difficult situation. The invasion of Ukraine by Russia on February 24th caused food and oil prices to skyrocket. As if left over from the pandemic, supply limits appeared to be present in every place. Inflation had to be brought down significantly in 2022 by the Fed, in contrast to the 1994 difficulty of preventing a robust economy from increasing inflation.
Despite these challenging circumstances, the central bank has landed the economy so softly that some economists are referring to the drop as the “immaculate disinflation.” Rose garlands should be removed. What a small miracle! How did Mr. Powell & Co. pull it off? The great Yankee pitcher Lefty Gomez famously said he’d “rather be lucky than good.” Federal Reserve has done both.
On the good luck side, the runup in oil and food inflation peaked around the time the Fed began to tighten. While there have been ups and downs since then, the basic trends in energy and food inflation have been down. Depending on how you measure them, supply-chain disruptions peaked in late 2021 or early 2022 and by now are basically gone. Remember “the Great Resignation,” people leaving the labor force in droves? With jobs plentiful, most of those workers have come back, boosting the supply of labor. All these developments were anti-inflationary.
However, competence was also shown by the central bank. After getting a late start, the Fed made up for lost time rapidly, raising the federal-funds rate more than 500 basis points in little over a year.
Through its steadfast rhetoric and previously earned reputation, the FOMC managed to keep inflationary expectations in check despite PCE inflation that rose above 7% and consumer-price-index inflation that reached 9%. One market-based indicator of this success was that the expected inflation rate implied by 10-year indexed bonds maxed out at about 3%. Another was that wage settlements remained moderate, never reaching 6% despite near double-digit CPI inflation.
This episode isn’t over. Things could still go wrong, and achieving a “soft landing” doesn’t mean that the plane never flies again. But we shouldn’t overlook the resounding success before us: that the U.S. economy has in fact already touched down softly.
Mr. Blinder is a professor of economics and public affairs at Princeton. He served as vice chairman of the Federal Reserve, 1994-96.
