Will Fed be able to pull off a soft inflation landing?
The Federal Reserve appears to be creeping closer to an outcome that its own staff economists viewed as unlikely just six months ago: Lowering inflation back to a normal range without plunging the economy into a recession.
Plenty could still go wrong. But inflation has come down notably in recent months — it is running at 3.1% on a yearly basis, down from a 9.1% peak in 2022. At the same time, growth is solid, consumers are spending, and employers continue to hire.
That combination has come as a surprise to economists. Many had predicted that cooling a red-hot job market with far more job openings than available workers would be a painful process. Instead, workers returned from the labor market sidelines to fill open spots, helping along a relatively painless rebalancing. At the same time, healing supply chains have helped to boost inventories and ease shortages. Goods prices have stopped pushing inflation higher, and have even begun to pull it down.
The Fed is hoping for “a continuation of what we have seen, which is the labor market coming into better balance without a significant increase in unemployment, inflation coming down without a significant increase in unemployment, and growth moderating without a significant increase in unemployment,” Fed Chair Jerome Powell said Wednesday.
As Fed policymakers look ahead to 2024, they are aiming squarely for a soft landing: Officials are trying to assess how long they need to keep interest rates high to ensure that inflation is fully under control without grinding economic growth to an unnecessarily painful halt. That maneuver is likely to be a delicate one, which is why Powell has been careful to avoid declaring victory prematurely.
But policymakers clearly see it coming into view, based on their economic projections. The Fed chair signaled Wednesday that rates were unlikely to rise from their 5.25% to 5.5% setting unless inflation stages a surprising resurgence, and central bankers predicted three rate cuts by the end of 2024 as inflation continues to cool and joblessness rises only slightly.
If they can nail that landing, Powell and his colleagues will have accomplished an enormous feat in U.S. central banking. Fed officials have historically tipped the economy into a recession when trying to cool inflation from heights like those it reached in 2022. And after several years during which Powell has faced criticism for failing to anticipate how lasting and serious inflation would become, such a success would be likely to shape his legacy.
“The Fed right now looks pretty dang good, in terms of how things are turning out,” said Michael Gapen, head of U.S. Economics at Bank of America.
Respondents in a survey of market participants carried out regularly by the research firm MacroPolicy Perspectives are more optimistic about the odds of a soft landing than ever before: 74% said that no recession was needed to lower inflation back to the Fed's target in a Dec. 1-7 survey, up from a low of 41% in September 2022.
Fed staff members began to anticipate a recession after several banks blew up early this year, but stopped forecasting one in July.
People were glum about the prospects for a gentle landing partly because they thought the Fed had been late to react to rapid inflation. Powell and his colleagues argued throughout 2021 that higher prices were likely to be “transitory,” even as some prominent macroeconomists warned that it might last.
The Fed was forced to change course drastically as those warnings proved prescient: Inflation has now been above 2% for 33 consecutive months.
Once central bankers started raising interest rates in response, they did so rapidly, pushing them from near-zero at the start of 2022 to their current range of 5.25% to 5.5% by July of this year. Many economists worried that slamming the brakes on the economy so abruptly would cause whiplash in the form of a recession.
But the transitory call is looking somewhat better now — “transitory” just took a long time to play out.
Much of the reason inflation has moderated comes down to the healing of supply chains, easing of shortages in key goods like cars, and a return to something that looks more like pre-pandemic spending trends in which households are buying a range of goods and services instead of just stay-at-home splurges like couches and exercise equipment.
In short, the pandemic problems that the Fed had expected to prove temporary did fade. It just took years rather than months.
“As a charter member of team transitory, it took a lot longer than many of us thought,” said Richard Clarida, the former Fed vice chair who served until early 2022. But, he noted, things have adjusted.
Fed policies have played a role in cooling demand and keeping consumers from adjusting their expectations for future inflation, so “the Fed does deserves some credit” for that slowdown.