Let’s start with the facts. The chart below points to inflation in the four soft-landings that have been identified since 1960 in a speech by Chairman Powell (Restoring Prices stability March 21, 2022). His speech identified the first three periods and then subsequently there was a result in 2017-2019 that also fits the description of a soft landing.
What’s clear in this chart is that there is no period for which a soft-landing has been designated and a rising inflation rate was turned into a lower inflation rate. The first episode around 1966 inflation actually spiked and then continued to move higher. In the 1984-episode, inflation was high but falling at a relatively moderate pace in the wake of the draconian recessions engineered by Paul Volcker to break the back of inflation in the early 1980s. The 1994-95 soft landing is the most publicized one. This is when Alan Blinder was Vice Chair at the Fed and Blinder frequently points at it today saying it was a success. But what’s clear in this chart, is that inflation was already on the decline before that soft landing began and inflation continued on a moderate decline. It’s not clear that policy had any impact on it at all. Similarly, in 2017-2019 there’s barely a blister of inflation subsequently, of course, Covid struck, and the world changed.
The big picture point of this chart is that soft-landings were not policies used to address high inflation and therefore they were not policies that successfully reduced high inflation. The idea of launching a soft-landing in the 2022-2023 period is completely alien to past experiences. The only soft-landing anything like today was in the mid-1960s when inflation moved up during a soft landing. Surely that isn’t what the Fed is seeking to do? If it is, you do not want to be betting on it being ‘a success.’
Chart two focuses on the federal funds rate. The nominal fed funds rate, of course, is the policy rate. Also on chart 2, I plot the real fed funds rate which is the nominal funds rate with the 12-month trailing PCE core inflation rate subtracted from it. This chart illuminates how the federal funds rate moved up and down through the various NBER business cycles as well as in the soft-landing periods. On the inflation chart it was actually hard to identify where the soft-landing periods were, however, on this chart it’s a little bit easier to see that there were actually policy changes in the federal funds rate even though there wasn’t much of a discernible impact on inflation. This is simply another way of pointing out that the relationship between the federal funds rate and the real fed funds rate to inflation in the soft-landing periods was a very loose one.
Soft landings are…
At this point it’s important to stop and assess exactly what a soft landing is. I’ve presented two charts above that show soft landings that clearly occur between recessions. And that’s the point of a soft landing; a soft landing is a period in which the Fed raises interest rates and it does not disrupt the economy very much. However, as we can see on the chart, that’s not a very ambitious policy. The Fed’s goal in raising interest rates is not to disrupt the economy although usually it must disrupt the economy in order to control inflation. The Fed’s goal usually is to raise rates to cool the economy and to bring inflation down. So, a soft-landing that brings the federal funds rate up and then brings it back down, doesn’t disrupt the economy very much, but doesn’t bring the inflation rate down, is not very useful at all. This is what soft-landings turn out to be- maybe not what was intended. The soft-landings listed in this table come from a speech given by Jerome Powell. These are acknowledged soft landings and yet they seem to have had no policy success whatsoever- except the rate hikes avoided causing recession.
This is why I find the Fed’s continued focus on soft-landings as inappropriate and misguided. The most obvious policy goal now is to reduce inflation. Inflation is clearly overheated and overshooting its target. But soft landings don’t do that.
The metrics of the soft-landing
If we look at the average column in the table above, we see the federal funds rate at an average soft-landing start of 4.26 percentage points, however, that’s largely because of soft landing #2 that occurred in the early recovery stages from the pair of 1980-81 recessions. The average hike in the Fed funds rate in these cycles is about two percentage points. We can compare that to the current period which we can’t yet call a cycle because it’s not clear what’s happening. But at this time we’ve seen the federal funds rate move up about five percentage points and the funds rate sits at a level of about 5%. The increase in the Fed funds rate is more than twice the normal rise in ‘soft-landings.’
Next look at inflation. The inflation rate averaged about 2.3% at the outset of these various cycles and ended about 2.6%. That makes the net increase of only 28 basis points. One year after the cycle, inflation is still at 2.3%; two years after the cycle, inflation is at about 3.4%. The soft-cycle does not affect inflation very much and two years later the inflation rate winds up higher.
The core inflation rate is a little bit more interesting. It’s an inflation rate that’s a little bit less battered around by exogenous events. The average core inflation rate averages 2.3% at the start of the recessions and ends at 3.5% for a gain of 1.2 percentage points, again that’s much lower than what we’ve seen in this period (a rise of 3.2%, on the core PCE- at one point even higher). One year after the end of the soft-landing in previous cycles, the PCE core pace was at 3%; two years later it averaged 4.25%, once again, this is evidence that soft-landings did not bring inflation to heel.
If we move back up in the table and look at the unemployment rate there’s another curiosity here; that is that in these periods when inflation was relatively stable and eventually rose later and, where the federal funds rate was raised, the unemployment rate generally fell during the soft-landing. These soft landings not only did not harm economic activity they seemed to have been associated with an increase in activity at least in the sense that the unemployment rate fell. This is not something we’d expect to happen in this cycle if the Federal Reserve were to successfully reduce inflation and stick with its tight monetary policy. These drops in the rate of unemployment while the Fed is hiking rates also make these periods unusual… probably not good soft-landing paradigms.
Chart 3 focuses on the period from the early-1960s to the mid-1980s. This period mixes in two soft landings with four official NBER recessions. The NBER recessions are designated by red bands while the soft landings are designated by green bands.
During the first soft-landing period in the mid-1960s we can see the inflation rate was quite stable coming into the period. But, during the soft-landing when the Fed was raising rates, inflation accelerated. The Fed stopped raising rates and inflation did back off slightly. However, the net result is that inflation had moved up to about 3% after having been about 1 1/2 percent before the soft-landing began.
Chairman Powell and others want to recall a soft-landing that’s a successful soft-landing. But these soft-landings are ‘successful’ only in the sense of ‘not creating a recession.’ They were not successful in corralling inflation, in fact, inflation stepped up and continued to accelerate into what then became a real NBER recession from 1969 to 1970 after the first ‘soft-landing.’ The Black Arc on the chart roughly sketches the inflation rate which went up and came back down in the NBER recession period (1969-70). Even in this official NBER recession, the inflation rate was not controlled; the PCE inflation rate wound up – after the recession – higher than it was in the aftermath of the previous soft landing (when it had accelerated). The mid-1960s to 1970s were a bad period for monetary policy.
The lesson here is a lesson about not just soft-landings but real recessions as well. This was a real recession. Interestingly former Fed Vice Chair Alan Blinder refers to the 1969-70 recession a ‘recessionette.” He wants to consider it as a ‘soft-landing.’ The unemployment rate only rose by 2.6 percentage points during this recession and while the inflation rate did rise and then fell slightly in the aftermath of the recession, the inflation rate was not returned to a position of price stability. In fact, the lowest the inflation rate got in recovery, for a very fleeting period, was 3.1%. Blinder, a soft-landing advocate, promotes this as success.
Recessions can fail to conquer inflation, too
That takes us to the next recession, a real recession, an NBR recession, from 1973 to 75. Again here we see that the inflation rate shoots up. The Federal Reserve raises the fed funds rate sharply but then pulls it back during the recession; as a result of that pull-back, the low point of inflation in the aftermath of the 1973-75 recession is only at 5.3%! That’s a clear escalation from its pre-recession level. This is a criticism of a policy in a recession that was a rather severe recession but where the Fed did not stick to its guns and keep the Fed funds rate high enough for long enough to bring the inflation rate back under control. Is there a lesson there for 2023? If so, I hope it’s one we have learned rather than one we must experience again.
The inflation story…
Inflation was not controlled until 1980-81 when Paul Volcker moved from the New York Fed to be Chairman of the Federal Reserve System. At that point interest rates shot up well above the inflation rate, a short sharp recession occurred, and then a longer, deeper, recession followed. With that the inflation rate fell and as the inflation rate fell, once again, the Fed let the federal funds rate come down – but the Fed was careful to keep the federal funds rate well above the inflation rate itself as it reduced it. This was not like 1975. Lesson learned? But is it a lesson remembered?
From 1983 to 1984 we see one of the soft-landing periods in green. This is the second soft-landing. And what’s clear during this period is that inflation was declining as it began, inflation declined only moderately during this episode. While the Fed raised the federal funds rate relatively sharply and then cut it quite abruptly. It’s certainly not clear from this chart exactly what the ‘soft-landing’ achieved.
Chart #4 focuses on the soft-landings through 1995 and once again you see the 1993- 95 soft landing at the end of this period. The federal funds rate goes up sharply; inflation remains flat and doesn’t do anything.
What is all the soft-landing rhetoric about?
These charts should raise some questions in your mind about what the Fed is doing and why Fed Chair Powell frequently talks about soft-landings. Powell says that one is still possible – why is he obsessed with this? As we can see soft-landings usually don’t solve any problems. Right now, we have a problem with inflation, we need to bring inflation down, we can see historically how we do that: (1) the Fed gets the federal funds rate above the rate of inflation and then, (2) keeps it there even once the inflation rate begins to fall in order to make sure that inflation comes under control.
Fast forward to 2023
There are widespread expectations in this economy that we will see some economic weakness this year and the Fed will start cutting rates this year and the Fed apparently will do that without getting the federal funds rate decisively above the inflation rate. There’s nothing in that market expectation about the Fed that is consistent with what we have learned historically about how to control inflation. There’s just a complete and total disconnect. And as we look back at the historic data, we can see that even in real recessions where the Federal Reserve raised rates enough to disrupt the economy, that didn’t bring the inflation rate down unless monetary policy continued to keep rates high for an extended period. In 2023 we can wonder if the level of rates is high enough and then speculate about Fed willingness to maintain rates in the face of weakness… if weakness emerges. When Federal Reserve officials tell us that they’ve raised rates and they don’t expect to cut them for a while, this is why. This is the lesson from history in landings both hard and soft. But markets remain skeptical.
Full employment Vs Price stability and the Powell Fed
There’s another lesson here and that’s the lesson from the business cycle. After the Covid recession there was massive fiscal stimulus and substantial monetary ease and then the Federal Reserve allowed the inflation rate, at least as measured by the CPI, to drift up nearly to 10% before it began to raise interest rates – it lollygagged for 12-months. The Federal Reserve is currently still operating with a framework agreement that emphasizes full employment more than price stability. Soft landings emphasize full employment. They do not emphasize price stability. However, even as the Fed has been talking about soft-landings it has gone out of its way to argue that it would bring inflation down to its target of 2%. However, the Fed has not told us how quickly or decisively it plans to bring the inflation rate down. So, when we combine what the Fed is saying about soft-landings and about getting inflation down to 2%, we get the less-than-reassuring picture of an inflation rate that’s going to linger at a much higher than 2% level for a substantial time before it comes down to the 2% level.
For these reasons I find the Fed’s policy communications quite confusing. The Fed’s policy goals are confusing. None of this leaves us with a very good feeling about the Fed and how it communicates with us. It certainly doesn’t make us understand why the Fed would continue at this time with inflation overshooting to talk about the possibility of a soft-landing. At this point the soft-landing simply isn’t good policy. The Fed should not be talking about it. To me it’s an indication that the Fed is still under great political pressure because, to many people, a soft-landing sounds like the Federal Reserve is going to try to get inflation under control without harming the economy. And, in some sense, that’s the goal. But history tells us that such a goal has been unachievable using a soft-landing. Soft-landings simply do not – never have – controlled inflation.
A warning for 2023 and beyond!
This article is a warning to younger traders who seem to be counting on a soft landing as they tune in to an expected 2% inflation outcome. It’s unclear, if left alone, where the inflation rate would go. I think it’s a heroic assumption that (1) if the Fed stops raising rates and (2) if the economy weakens that, (3) the Fed would be able to let the federal funds rate come down and that the inflation rate would settle in at 2%. These are the metrics everybody is seeking but there’s no evidence that these are the things that would happen.
Expectations… the missing link?
Some may be looking at these surveys of inflation expectations, but I have not talked about them in this article at all. The reason is that there is no evidence that inflation expectations have ever adequately projected what inflation is going to be. Inflation expectations simply do not move around as much as inflation does and in surveys people are reluctant to change their inflation expectations very much. However, if we look at the ranking of current inflation expectations, we find that compared to past inflation expectations current expectations are quite high. Numerically they don’t seem that high because they’re not high relative to actual inflation. But, relative to the expected values that people have been willing to project in the past, inflation expectations are relatively high. I place more stock in that ranking statistic than in the absolute level of inflation expectations. The take-away: People are fearful of inflation not confident that it will remain well-behaved.
This time it’s different – everything is different
The phrase, “this time it’s different,” is often taken to be a sarcastic statement about prospects. When economists as forecasters appeal to the idea that the future is going to be different from the past for some unspecified reason it’s a good time to be skeptical about that and check for your wallet. However, there’s a lot in this economy that is different- that has been different. Since the Great Recession, the charts clearly show that real interest rates have been lower consistently and lower until Covid struck. Those very low real interest rates were consistent with very moderate inflation and growth and low unemployment. It wasn’t until Covid struck, when fiscal policy became extremely stimulative, and was joined with a very stimulative monetary policy, that inflation really got out of hand. I believe Covid was the trigger for bad policy.
The New Normal strikes…
There was a long period in the wake of the Great Recession in which the global economic environment was an anti-inflation environment. There was a lot of sourcing from low wage countries; there was a lot of technology; the internet became more important; a lot of factors culminated in creating that environment. It was quite different from previous periods. The question now is, “how different is this period going to be?” Are we going to retain the distinctiveness and the anti-inflation aspects of the post Great Recession period, or not? This is an extremely important question. We know that supply chain issues contributed to inflation in the wake of the Covid recession. We also know that a lot of firms have shifted their supply chains and learned from Covid and moved to supply chains that are more secure rather than simply seeking out the lowest-cost labor. Furthermore, because inflation is high we have higher inflation expectations. We no longer have the same situation of price stability with full confidence in the Fed and other global central banks. And there is a disruptive war.
…and the winning strategy is:
It is therefore highly speculative to think that inflation is going to return to the 2% or sub 2% level that had prevailed prior to Covid. These are things that investors are going to have to puzzle-out as they price securities and get ready for the environment that lies ahead. These are not things that we can know. These are things, at this point, we can have opinions about. We can point to various facts or factors that support one point of view or the other and try to learn from history. But, at this point, there’s no way to know exactly how fast inflation will recede and what pace it will stabilize.
Speaking as someone who began working on Wall Street in the late 1970s when we had a clear inflation problem, I remain more skeptical than a lot of the young Wall-Streeters who have spent a lot of time in this low inflation environment and have come to view it as something that is more permanent. Flash notice: the new ‘permanent’ is temporary! The world is cyclical, the pendulum swings. When I look at Fed policy, I want to see a Federal Reserve that is going to make sure that inflation is going to be under control. I don’t want to see a Federal Reserve policy that is assuming that inflation is going to hit its target and not taking the steps to make sure that it happens. That of course is a generational difference in views between the older and younger market professionals. Someone will turn out to be right and someone will turn out to be broke.