Sunday, October 29, 2006

The Previous 'Soft Landing'

Has the Fed managed to raise interest rates by exactly enough to bring the US economy down to a "soft landing"? There was substantial disagreement among economists about Friday's GDP report, with some arguing that it was a harbinger of a looming recession, while others argued that it was still consistent with the soft landing scenario, and didn't really contain anything to worry about.

We won't know which camp was closer to the truth for many months. But in the mean time, I can't help but be reminded of the discussions happening among economy-watchers in mid- to late-2000. The situation in 2000 was somewhat similar to today's economy in some ways; in particular, the Fed had been raising interest rates for some time in an attempt to cool the economy and bring down incipient inflation without pushing the economy into a recession, and many observers were of the opinion that they had succeeded. To help refresh your memory, here are some excerpts from the news at the time (sorry, I haven't tracked down links):
August 10, 2000
The Boston Globe
Economy Slowing for 'Soft Landing; Fed Reports Braking in Key Growth Areas: The hard-charging US economy slowed in the late spring and early summer, the Federal Reserve reported yesterday, suggesting a "soft landing" for the 10-year expansion indeed could replace the traditional boom-and-bust dynamic...

September 2, 2000
The Washington Post
Economic Growth Gradually Slowing; Reports May Reduce Chance of Rate Hike: More clearly than ever, three new economic reports out yesterday show the U.S. economy coming in smoothly for a soft landing. A series of increases in short-term interest rates by the Federal Reserve and other forces have combined to slow economic growth just enough to keep inflation largely at bay without significantly raising the risk of a recession.

The reports all pointed in that direction, according to a number of analysts, who also said the way events are unfolding suggests that Fed policymakers won't be raising rates again anytime soon.

September 18, 2000
The Wall Street Journal
Economic Data Continue to Augur Soft Landing:

October 28, 2000
Cleveland Plain Dealer
Economy Cools to Rate Suggesting Soft Landing: The economy shifted into a much lower gear during the summer, registering its slowest speed in more than a year and reflecting a drop in government spending and weaker business investment... "We have downshifted ... but we're not on the brink of a recession," said Paul Kasriel, chief economist for Northern Trust Co. The report, he said, is consistent with the Federal Reserve's desire to bring the high-flying economy down to a more sustainable rate of growth.

October 29, 2000
The Atlanta Journal and Constitution
Stock market fall hurts, but 'soft landing' helps

November 27, 2000
Business Week
This Political Shock Won't Upset the Soft Landing: THE FED SEEMS CONTENT that the slowdown is leading toward the desired soft landing, although policymakers are still not convinced that the threat of rising inflation is abating. After hiking its overnight rate from 4.75% in June, 1999, to 6.5% in May, 2000, the Fed at its Nov. 15 policy meeting continued to leave interest rates unchanged. The Fed admitted that the economy could slow to a pace even below its long-run trend, generally taken to be 3.5% or so. However, it said that the slowdown in demand to date has not been sufficient to alter its view that the risks in the outlook are weighted toward conditions that could generate higher inflation.

...The bottom line is that, yes, the economy is slowing as the Fed's efforts to pull off a soft landing bear fruit. And little indicates that this nation's ongoing political shock will rattle the economy, especially since the fundamentals remain quite sturdy. The Greenspan Fed pulled off a soft landing in 1994, and it will very likely succeed again in 2001 -- regardless of how long it takes to elect a President.

Dec 7th, 2000
The Economist
Slowing down, to what?: The latest economic figures are consistent with a soft landing. As Mr Greenspan made plain in his speech, an economic slowdown is what the Fed has been aiming to achieve by raising interest rates six times in the past 18 months. By creating economic slack, this should stop inflation rising further. And despite the share-price jump this week, recent market edginess will usefully remind investors about risk and so deter reckless investment.

The markets are also right that few economists are actually predicting a hard landing. The average forecast for growth in 2001 by 15 economists polled by The Economist this week was 3.0%.
For reference, we now know that the US economy experienced negative economic growth between July and September of 2000, and officially entered a recession in early 2001.

My point is a relatively simple one: I don't think that we have nearly enough evidence yet to conclude that the Fed has acheived a soft landing for the US economy. Any guesses about how rough the landing will be will thus have to be based on guesses, predictions, and assumptions about how consumers and businesses will behave over the next several months. So I would be hesitant to congratulate the Fed on its successful soft landing until we know (maybe by mid-2007) if the relatively optimistic suppositions about future consumer and business behavior were right.

It's also worth noting that even as late as November 2000, the signals from the Fed and the interpretation of Fed-watchers were that the chances were that the next interest rate move by the Fed would be an increase. Now we know, of course, that they were compelled to decrease interest rates just a few weeks later. So despite the Fed's rhetoric to the contrary, I would still be cautious in believing that the Fed's next move in the current episode will end up being another increase.


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