The pressure from the Federal Reserve to slow down the economy and bring inflation under control has often been likened to an airplane drop, one that could end in a soft landing, a bumpy landing, or an outright crash.
Jerome H. Powell, the Fed chairman, is betting on something more akin to the Miracle on the Hudson: a soft landing, all things considered, and unlike anything the nation has seen before.
The Fed has raised interest rates sharply over the past year, to just above 5 percent on Wednesday, in an effort to cool the economy and bring inflation under control. Central bank economists are beginning to predict that America is likely to slide into recession later this year as the Fed’s substantial policy changes coupled with banking sector turmoil will dampen growth.
But mr. Powell made it clear during a press conference on Wednesday that he disagrees.
“That’s not my own most likely case,” he said, explaining that he expects modest growth this year. This brighter forecast partly depends on developments in the labor market.
The US job market is still very strong – with rapid job growth and unemployment float close by a 50-year low — but it’s showing signs of cooling. The number of vacancies has fallen sharply in recent months 9.6 million in March from a peak of over 12 million a year earlier. Historically, such a massive reduction in available positions would have been accompanied by layoffs and rising unemployment, and prominent economists had predicted precisely for that reason a painful economic landing.
But so far unemployment has not decreased.
“It was not intended that vacancies would decrease as much as they have decreased without unemployment rising,” said Mr. Powell this week. While America will get its latest update on unemployment when a jobs market report is released Friday, unemployment has yet to rise significantly.
Mr Powell added that “there are no promises in this, but it just seems to me that it is possible that we could continue the cooling down of the labor market without the large rises in unemployment that have come with many previous episodes. ”
America’s economic fate depends on whether Mr. Powell is correct. If the Fed manages to pull it off—defying history to quell rapid inflation by sharply cooling the labor market without triggering a large and painful jump in unemployment—the legacy of the post-pandemic economy could be a tumultuous one. but ultimately can be a positive legacy. Failing that, taming price increases could mean painful costs for American workers.
Some economists are skeptical that the good times can last.
“We haven’t seen this trade-off, which is fantastic,” said Aysegul Sahin, an economist at the University of Texas at Austin. But she noted that productivity data seemed bleak, suggesting companies have been burned by years of pandemic labor shortages and are now holding on to workers even when they don’t necessarily need them to produce goods and services.
“This time was different, but now we’re going back to the state where it’s a more normal job market,” she said. “This is going to play like it always plays.”
The Fed is responsible for promoting both maximum employment and stable inflation. But those goals can conflict with each other, as they do now.
Inflation has been above the Fed’s 2 percent target for two full years. Although the strong labor market was not initially the cause of the price spikes, it could help to perpetuate them. Employers pay higher wages to retain employees. As they do, they raise prices to cover their costs. Employees who earn a little more can afford rising rents, childcare costs and restaurant checks without withdrawing.
In such situations, the Fed raises interest rates to cool the economy and the labor market. Higher borrowing costs slow down the housing market, discourage large consumer purchases such as cars and home improvement projects, and deter companies from expanding. Because people are spending less, companies can’t keep raising their prices without losing customers.
But setting policy correctly is an economic tightrope.
Policymakers believe it is of the utmost importance to act decisively enough to bring inflation under control quickly. If inflation lasts too long, households and businesses can expect steadily rising prices. They can then adjust their behavior, ask for bigger raises and normalize normal price increases. That would make it even more difficult to stamp out inflation.
On the other hand, officials don’t want to cool the economy too much, triggering a painful recession that proves to be more severe than it took to bring inflation back to normal.
Finding that balance is a tricky proposition. It is not clear exactly how much the economy needs to slow down to bring inflation fully under control. And the Fed’s rate policy is blunt, imprecise and takes time to work: It’s hard to guess how much the hikes so far will ultimately weigh on growth.
That’s why the Fed has slowed down its policy changes in recent months — and why it seems ready to pause them altogether. After a series of interest rate moves of three-quarters of a point last year, the Fed has recently adjusted borrowing costs by a quarter of a point at a time. Officials indicated this week that they could stop raising rates from their mid-June meeting, depending on incoming economic data.
A pause would give central bankers a chance to see if their rate adjustments so far could be enough.
It would also give them time to assess the impact of the banking sector turmoil – one that could make a soft economic landing even more difficult.
Three major banks have collapsed and required government intervention since mid-March, and the jitters continue to ripple through medium-sized lenders, with several regional bank stocks plummeting on Wednesday and Thursday. Banking problems can quickly translate into economic problems as lenders withdraw, leaving businesses less able to grow and households less able to finance their consumption.
The job market could see a more dramatic slowdown given the banking turmoil and interest rate moves from the Fed so far, said Nick Bunker, the director of North American economic research at the job site Indeed.
He said that while job openings are shrinking rapidly, some of that may reflect a shift back to normal after a period of pandemic-inspired weirdness, not necessarily as a result of Fed policy.
For example, the number of vacancies in the leisure and hospitality sector had soared as restaurants and hotels reopened after lockdowns. Those were now disappearing, but that could be more about a return to business as usual.
“There is a soft landing, but how much of it is gravity and how much of it is the pilot doing with the plane?” said Mr. Bunker. Going forward, it could be that the normal historical relationship between declining job vacancies and rising unemployment will kick in as policy starts to bite.
Or this time could be truly unique – as Mr. Powell hopes. But whether the Fed and the U.S. economy can test his thesis may depend on solving the problems with the banking system, Bunker said.
“We may not get an answer if the financial sector comes and knocks the table,” he said.