The Federal Reserve’s push to slow the economy and bring inflation under control is often compared to a plane crash that could end in a soft landing, a bumpy landing, or an outright crash.
Fed Chairman Jerome H. Powell is betting on something more akin to the Miracle on the Hudson: a touchdown that’s overall gentle and unlike anything the nation has seen before.
The Fed hiked interest rates sharply over the past year, bringing rates down to just over 5 percent on Wednesday in a bid to cool the economy and bring inflation under control. Central bank economists have begun to forecast that America is likely to slip into recession later this year as the Fed’s significant monetary policy moves combine with the turmoil in the banking sector to wipe out growth.
But Mr Powell made it clear during a press conference on Wednesday that he disagreed.
“That’s not my personal most likely case,” he said, explaining that he expects modest growth this year. This sunnier forecast depends in part on trends in the labor market.
The US job market is still very strong – with fast job growth and unemployment hovering near a 50-year low – but there are signs of a slowdown. Job vacancies have fallen sharply in recent months, falling to 9.6 million in March from a peak of more than 12 million a year earlier. Historically, such a massive drop in available jobs would have been accompanied by layoffs and rising unemployment, and prominent economists had predicted a painful economic landing for precisely this reason.
But so far unemployment hasn’t budged.
“It shouldn’t be possible for job openings to fall as much as they’ve been falling without unemployment rising,” Mr Powell said this week. While America will get the latest unemployment update when a jobs report is released on Friday, unemployment has yet to rise significantly.
Mr Powell added: “There are no promises, but it just seems to me possible that we can see a further slowdown in the labor market without having the sharp rise in unemployment that has accompanied many previous episodes. ”
America’s economic fortunes depend on whether Mr. Powell’s optimism is correct. If the Fed manages to defy history to combat rapid inflation through a sharp slowdown in the labor market without causing a large and painful rise in unemployment, the legacy of the post-pandemic economy could be a turbulent but ultimately positive one be. If that isn’t possible, taming price increases could come at a painful cost to America’s workers.
Some economists are skeptical that the good times can last.
“We didn’t see that compromise, which is fantastic,” said Aysegul Sahin, an economist at the University of Texas at Austin. However, she noted that productivity data looked bleak, suggesting firms have been seared by years of pandemic labor shortages and are now holding on to workers even if they don’t necessarily need them to produce goods and services.
“It was different this time, but now we’re going back to where it’s a more normal labor market,” she said. “This will play out as it always plays out.”
The Fed is responsible for promoting both maximum employment and stable inflation. But these goals can conflict, as is the case now.
Inflation has been above the Fed’s 2 percent target for two full years. Although the strong labor market did not initially cause the price spikes, it could help to perpetuate them. Employers are paying higher wages to try to keep workers. They raise prices to cover their costs. Those who earn a little more can afford rising rents, childcare costs, and restaurant checks without retiring.
In such situations, the Fed hikes rates to cool the economy and job market. Higher borrowing costs slow the housing market, discourage large consumer purchases like cars and home improvement projects, and discourage businesses from expanding. As people spend less, companies cannot keep raising prices without losing customers.
But getting politics right is an economic tightrope act.
Policymakers believe it is paramount to act decisively enough to bring inflation under control quickly – if it persists too long, families and businesses could expect steadily rising prices. They could then adjust their behavior, demanding higher salary increases and normalizing regular price increases. That would make it even harder to root out inflation.
On the other hand, officials don’t want the economy to cool down too much, causing a painful recession that’s proving more punishing than it would take to normalize inflation.
Finding that balance is a tricky business. It’s not clear how much the economy will need to slow to fully control inflation. And the Fed’s interest rate policy is blunt, imprecise and takes time: It is difficult to estimate how much the previous increases will ultimately weigh on growth.
That’s why the Fed has been slowing its policy changes for the past few months — and seems poised to halt them altogether. After a series of three-quarter-point interest rate moves over the past year, the Fed recently adjusted borrowing costs by a quarter-point at a time. Officials signaled this week that they could stop raising interest rates entirely as early as their mid-June meeting, depending on incoming economic data.
A pause would give central bankers a chance to see if their past rate adjustments might be enough.
It would also give them time to assess the fallout from the turmoil in the banking industry — turmoil that could make a soft economic landing even more difficult.
Three major banks have collapsed since mid-March, requiring government action, and jitters continue from mid-tier lenders, with several regional bank stocks tumbling Wednesday and Thursday. Banking problems can quickly turn into economic problems as lenders pull out, leaving businesses less able to grow and families less able to fund their consumption.
The job market could be in for a more dramatic slowdown given the banking turmoil and the Fed’s rate hikes so far, said Nick Bunker, director of North American economic research at jobs site Indeed.
He said that while job vacancies had fallen quickly, some of them may reflect a return to normal conditions after a pandemic-related frenzy that wasn’t necessarily due to Fed policy.
For example, job vacancies in the leisure and hospitality industries had skyrocketed as restaurants and hotels reopened after lockdown. These have now disappeared, but that could mean more of a return to normal business.
“There is a soft landing, but how much of it is gravity and how much of it is the pilot doing to the plane?” Mr. Bunker said. Going forward, the normal historical relationship between declining job vacancies and rising unemployment may come into play when politics starts to bite.
Or that time could be truly unique – as Mr. Powell hopes. But whether the Fed and the US economy could test his thesis could depend on whether problems in the banking system clear up, Mr Bunker said.
“We may not get an answer if the financial sector comes along and shakes the table,” he said.
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