A Soft Landing Won’t Mean the Economy Is Safe


Since we have given up on the idea that high inflation will be temporary, the hope is that we will manage a soft landing: Inflation will melt back to 2% without harming the labor market or economic growth. That’s what the Federal Reserve has been predicting for months, even as economists warn it may not happen. Now it seems a soft landing is a real possibility. Inflation has fallen and the labor market remains strong with unemployment at a 50-year low and wage growth at 4.6%.

If these trends continue, the “immaculate disinflation” envisioned by the Fed will become a reality. But don’t celebrate yet. That doesn’t mean we dodged a bullet.

A soft landing is obviously better than a hard one. A hard landing means more people will lose their jobs and then the terrible labor market will bring down inflation. Some of the more encouraging aspects about today’s job market are that unemployment is very low among people with a high school education or less, and most of the job growth is happening in small businesses. . In a recession, those are the groups that get hurt the most.

Yet the labor market is not as good as it seems. Nominal wage growth may appear high, but after accounting for inflation, many households – especially low-income ones – are getting poorer. Much would be better if nominal wage increases were lower, but inflation, too.

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The problem with a soft landing is that it drags on this inflation cycle. That means many months (or years) where wages can’t keep up with rising prices, pushing some households into more debt. One reason some people are optimistic that a recession will be mild is that household balance sheets are in good shape coming out of the pandemic. But the longer the slog out of inflation, the more households will burn through their savings. There is already evidence that they are running up credit card debt.

A soft landing also means higher interest rates for a longer period of time, which could disrupt the financial system or cause problems for companies that rely on cheap debt. This scenario will also be more difficult for small businesses because they have less ability to raise prices and less access to credit.

Another risk of a soft landing is that the cycle is incomplete. Inflation may pick up but then stall at 4% or 5% while the labor market remains in a good place. At that point the Fed will be left with a difficult choice. It will do real damage to bring inflation back to 2% at a time when the economy is in a weaker place. Or, the more likely outcome, the Fed simply learned to live with higher inflation and took the win.

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But living with moderate inflation also brings costs. This shows that the Fed will not meet its target and the central bank is losing more credibility. It needs credibility to have an impact on the economy in the future (including boosting the economy in the next recession). Above-target inflation also means higher interest rates for the foreseeable future because bond buyers will need more yield to compensate for the increased inflation risk. Higher rates for the long term will translate into higher mortgage rates and a bad shock for local and foreign markets.

However, if the soft landing scenario were to happen, the economy would be able to bounce back without much damage as long as it does not suffer another major shock. And that’s a big if. The global economy is more uncertain than before the pandemic. Some sources of concern are:

• Political corruption. A divided Congress and a weak House of Representatives speaker are less likely to pass budgets and cut spending when necessary. The risk of an actual debt default is low, but the turmoil in Washington increases uncertainty in the US economy and could lead to higher interest rates and a weaker dollar.

• More pain. The Covid-19 pandemic is largely over, but you never know what may emerge in terms of variants or new viruses.

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• Foreign political risk. Things could get worse in Russia or China. Higher prices also pose more problems for emerging markets. All of this creates more supply chain issues and higher energy and food prices.

Those are the only threats we can easily think of. The biggest risk from a soft landing is that it weakens the economy’s resilience to future shocks, making us more vulnerable in the long run to whatever comes next. It may be better than a bad recession in the short term, but the many risks show why high inflation is so difficult to manage, and why it can cause so much damage in the years to come. .

More From Other Bloomberg Opinion Writers:

• Price Increases Good for Us, Bad for Stores: Andrea Felsted

• Who’s Afraid Of A Big Bad Rate Pause?: Daniel Moss

• Rental Housing Heads for Hard Landing: Conor Sen

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Allison Schrager is a Bloomberg Opinion columnist covering the economy. A senior fellow at the Manhattan Institute, he is the author of “An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk.”

More stories like this are available at bloomberg.com/opinion


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