Monday, February 20, 2023

What is the likelihood of a soft landing? History provides some insights

The "soft landing" meme has taken over the language of the business cycle. The word recession is not used. An economic slowdown below the long-term trend, albeit a mouthful, is not used. We have types of landings, hard and soft. 

So how has the Fed done at engineering a soft landing? According to Alan Blinder in "Landings, Soft and Hard: The Federal Reserve, 1965-2022", the Fed has been able to engineer these soft landings in the past although the odds still show a hard landing is possible. 

Blinder looks at Fed interest rate increases and then matches with the combination of whether inflation is higher or lower and whether there was a recession. The table shows the size of the rate increase, the direction of inflation, and the landing as measured by whether there was a large or small recession. The figure shows the move in nominal interest rates. We are now pushing 5%. 

For the eleven episodes identified by Blinder, five were hard landings but two were not due to the Fed by Blinder's assessment. Seven were soft landings. The odds favor a soft landing but if you condition on the rise in rates, the likelihood of a hard landing increases.  


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