VSfor 2024 will it be an unprecedented year in post-war American economic history? Not since 1945 has annual inflation, as measured by the Consumer Price Index, fallen from more than 5% to less than 3% without a recession at the time of the fall or in the 18 months following.
Yet professional forecasters surveyed by the Federal Reserve Bank of Philadelphia say that by the end of 2024, overall annual inflation will be 2.5%, while actual inflation GDP will increase by 1.7% over the year, roughly in line with its long-term trend. Financial markets are rejoicing at the prospect of such asoft landing“.
The Fed has been fighting inflation by raising interest rates since March 2022. Monetary tightening usually causes a recession because deflating an economy is a bit like deflating a balloon: It’s hard to do smoothly. There have been cases where rate hikes did not lead to a slowdown, such as in the mid-1980s and late 1990s (and other times when events, like the Covid-19 pandemic, intervened). But on those occasions, inflation had not reached 2022 highs. The fact that the Fed raised interest rates so quickly in 2022 and 2023 would make a soft landing all the more exceptional.
When will it become clear that the economy has landed? Inflation data is less revised than other economic data, so the Fed would likely hit its target in plain sight. Given that it is rare for inflation to settle precisely at 2%, it would be fair to declare that the target has been achieved if annual headline inflation and annual core inflation, which excludes prices volatile food and energy prices, fell below 2.5% on the Fed’s preferred price index. , which rises a little more slowly than the CPI.
Over the past three months, US core inflation has increased at an annualized rate of just 2.2%. If this continues, the annual measure would fall below 2.5% in February. Without, for example, a rise in oil prices, headline inflation would probably also have reached its target.
The other criterion for a soft landing – avoiding an economic downturn – is more difficult to assess. Recessions tend not to start until a long time after they hit. In the past, the most reliable real-time indicator one could start with was the “Sahm Rule”. It is triggered when the three-month moving average of the unemployment rate increases by 0.5 percentage points from its lowest level in the previous year. The rule has identified every U.S. recession since 1960, with no false positives. Today, unemployment is up 0.3 percentage points from its lowest level in mid-2023.
The Sahm rule could collapse this time around, as labor markets have been exceptionally tight since the pandemic. It would be completely natural for the unemployment rate to increase a little. Claudia Sahm, who invented the rule, warned that it was distorted by the return to the job market of people who left during the pandemic, which drives up the unemployment rate even in the absence of layoffs.
But in this case, the rule will result in a false announcement of a recession, rather than missing a slowdown. If the Fed achieves its inflation target without the Sahm rule being triggered, we could therefore say that the plane has landed.
However, this would not have stopped. In the early 1950s and early 1970s, recessions hit nearly a year and a half after inflation fell. Nor would policymakers have finished adjusting controls. At its December meeting, the Fed indicated it planned to cut interest rates by three-quarters of a percentage point in 2024.
He wants to ease monetary policy in part because he believes the natural resting point for interest rates is below their current level. If the Fed is wrong, interest rate cuts will act as unwarranted stimulus and inflation will reaccelerate. Fiscal policy will also remain crisis-oriented, given America’s huge underlying deficit, which has reached 7.5% of GDP. GDP in fiscal 2023. Reducing that significantly could hurt.
The other reason to be cautious is that we often talk about a soft landing just before the recession hits (see chart). And this happens in normal economic cycles. Since pandemic forecasters poorly executed, underestimating growth and, until recently, inflation. That they now think a soft landing is coming is good news. But don’t believe it until you see it. ■