By Nicole Goodkind, CNN Business
Wide jeans, butterfly clips and half-point rate increases: the 1990s are back.
Earlier this month, Federal Reserve Chairman Jerome Powell announced a half-percent hike in interest rates, the biggest hike in more than two decades. Powell also signaled he wouldn’t hesitate to do it again – a decision straight out of the central bank’s playbook of 1994, when the Fed last tempered the US economy and pulled off a so-called soft landing.
In the 12 months since 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-quarters of a point.
“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 the Fed should raise interest rates to reduce economic demand and maintain price stability. They simply disagree on what this will mean for the economy as a whole.
The history of central bank rate hikes seems to confirm the inevitability of an economic downturn, but there have been rare instances when the Fed has made a soft landing: once in 1965, then again in 1984 and 1994.
Over the next few months, the Fed will attempt to engineer a cooling economy that will drive prices down but not escalate into a recession. It is a Goldilocksian task that some, including former Federal Reserve Bank of New York President Bill Dudleythink it will be almost impossible to execute.
Powell’s notorious Fed critic Larry Summers rated the likelihood of central bank actions leading to a hard landing at 100%. Goldman Sachs analysts say it’s closer to a one in three chance.
But Powell remains convinced that 1994 has more to offer us than reruns of The Lion King and Ace of Base.
“I believe the historic record gives reason for optimism: soft landings, or at least soft landings, have been relatively common,” Powell said in a statement. March Speech.
But there are major differences between 1994 and 2022, and the timing may be the most important factor.
Greenspan has proactively increased its rates. He saw that the economy was booming and wanted to get ahead of the inevitable inflation. Powell was more responsive. He raised rates by just half a percentage point after inflation hit levels not seen in decades. It is possible that the Fed is too far behind the curve to be able to dampen inflation without inflicting economic hardship on Americans.
Employment today is not what it was then. In 1994, baby boomers were at the height of their careers, many new technologies were being introduced into the workplace, and the number of immigrants was high. All of this led to a huge labor force and productivity rates that kept unemployment low even as interest rates rose. In 2022, we are facing baby boomers ready to leave the labor market, a significantly reduced participation rate due to the pandemic and a slowdown in productivity.
“In the past, when you’ve driven the unemployment rate up, you’ve almost never been able to avoid a full-blown recession,” Dudley said. “The problem the Fed is facing is that it’s just late.”
Cradled by world events
Geopolitical luck was also a factor in the soft landing of 1994, and despite the best efforts of economists, luck cannot easily be replicated.
The North American Free Trade Agreement (NAFTA) was adopted in 1994 and the Berlin Wall had come down five years earlier. Both of these events increased the availability of imports and lowered the cost of goods. Today, globalization is in retreat as the pandemic and war in Ukraine have led to significant energy price shocks and supply chain disruptions.
“On closer inspection, Greenspan’s Fed enjoyed considerable fortune, which the current Fed is unlikely to enjoy,” wrote Carl Tannenbaum, Northern Trust’s chief economist, in a research note. “None of that is to say a soft landing is impossible this time around. But the degree of difficulty is much higher than 28 years ago.
There may still be room for a soft landing, as long as you’re willing to tweak the definition a bit. We’ve seen 11 instances of the Fed’s tightening policy since 1965 (not counting current moves), said Princeton economist Alan Binder. Seven of them led to a drop in economic output of less than 1%, a relatively small slowdown. “So soft landings can’t be that hard to achieve,” he concluded.
After all, a soft landing may be the best we can hope for.
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