Earlier this month, Federal Reserve Chair Jerome Powell announced a half a percentage point rate hike, the largest hike in over two decades. Powell also indicated that he would not hesitate to do so again — a move straight out of the central bank’s playbook from 1994, when the Fed last slowed the US economy and successfully executed a so-called soft landing.
In the 12 months after February 1994, the Fed, under former Chairman Alan Greenspan, nearly doubled interest rates to 6% in just seven hikes, including two half-point hikes and one three-quarter-point hike.
“Eat your heart out, 1994,” Morgan Stanley analysts wrote in a note following Powell’s comments.
Inflation rates are near 40-year highs and most economists agree that the Fed should raise interest rates to reduce economic demand and maintain price stability. They just disagree on what that will mean for the economy as a whole.
The history of central bank rate hikes seems to support the inevitability of an economic downturn, but there have been rare instances when the Fed has made a soft landing: once in 1965 and again in 1984 and 1994.
Over the next few months, the Fed will try to create an economic slowdown that will lead to lower prices, but not a recession. It’s a Goldilocks task that some, including former New York Federal Reserve Bank President Bill Dudley, believe will be nearly impossible to accomplish.
Larry Summers, a well-known critic of Powell’s Fed, has put the probability that the central bank’s actions will result in a hard landing at 100%. Analysts at Goldman Sachs say the odds are closer to one in three.
But Powell remains convinced there’s more to 1994 than reruns of The Lion King and Ace of Base.
“I think the historical record is optimistic: Soft landings, or at least soft landings, were relatively common,” Powell said in a speech in March.
But there are some big differences between 1994 and 2022, and timing might be the most important factor.
Greenspan proactively raised interest rates. He saw that the economy was booming and wanted to forestall the inevitable inflation. Powell was more reactive. He only raised interest rates by half a percentage point after inflation had risen to levels not seen in decades. There is a possibility that the Fed is too far behind the curve to dampen inflation without causing economic hardship for Americans.
The job today isn’t what it was then. In 1994, baby boomers were at the peak of their careers, many new technologies were being introduced into the workplace, and immigration was strong. All of this resulted in an enormous labor force and productivity rates that kept unemployment low even as interest rates rose. In 2022, we face boomers poised to retire, a labor force participation rate significantly reduced by the pandemic, and a slowdown in productivity.
“In the past, when you drove up the unemployment rate, you almost never avoided a full-blown recession,” Dudley said. “The problem with the Fed is that they’re just too late.”
Shaken by world events
Geopolitical luck was also a factor in the 1994 soft landing, and despite the best efforts of economists, luck is not easily replicated.
The North American Free Trade Agreement (NAFTA) was passed in 1994 and the Berlin Wall had fallen just five years earlier. Both events increased the availability of imports and reduced the cost of goods. Today, globalization is in retreat as the pandemic and war in Ukraine have led to major energy price shocks and supply chain disruptions.
“On closer inspection, the Greenspan Fed was the beneficiary of considerable good fortune that the current Fed is unlikely to enjoy,” wrote Carl Tannenbaum, Northern Trust’s chief economist, in a research note. “All this is not to say that a soft landing is impossible this time. But the level of difficulty is much higher than it was 28 years ago.”
There can still be room for a soft landing, as long as you’re willing to tweak the definition a bit. We’ve seen 11 instances since 1965 of the Fed tightening monetary policy (excluding the current moves), said Princeton economist Alan Binder. Seven of these led to a fall in economic output of less than 1%, a relatively small fall. “Landings that soft can’t be too difficult to achieve,” he concluded.
After all, a soft landing might be the best we can hope for.