Hunting for a unicorn: The Fed’s quest for a soft landing

History indicates soft landings are scarce, perhaps nonexistent, and the challenges that the U.S. economy and Fed policymakers face in the coming months show why.

Initial reports indicate that despite rising oil prices and mortgage and credit card rates, gross domestic product advanced robustly in the third quarter, fueled by strong consumer spending and President Biden’s investments in infrastructure, green energy and the semiconductor supply chain.

But inflation outpaced wage growth through much of the recovery, and consumers have been making up the difference by using savings temporarily boosted by COVID-19 relief programs.

Those savings are running out, and most consumers will have to trim their sails or go into debt. But with credit conditions tightening, running up credit card balances, taking out second mortgages, and the like are unattractive.

Restarting student loan payments will also subtract $100 billion annually from household budgets.

With services driving the recovery, steps such as eating at home more, attending fewer concerts, etc., are not terribly difficult. Despite the wailing, households can trim consumer spending without much difficulty.

Oil prices jetted north in recent months due to the Saudi-Russian pact to work with OPEC to curb production. That erodes buying power and pushes up prices for gasoline and heating oil and costs in transportation, construction and household products, construction and so on.

The surge in consumer prices since August so far mostly reflects only the bump to fuel and home energy prices. It did not exhibit most knock-on effects in other industries.

The first half of this year, in an array of industrial activities that produce everyday items such as laundry detergent, the bottles for your water and other plastic packaging, fresh produce, meat and other groceries, costs were kept down and profit margins and stock prices were elevated by tame material costs and the post-COVID healing of supply chains.

Now CEOs face not just higher oil prices but tightening supplies of other commodities, an end to falling logistics costs, and thinner profits. They must exercise their pricing power to protect profit margins and support stock prices, or at least prevent stock prices from sliding too much as the economy slows or sinks into a recession.

The surveys conducted by Bloomberg and The Wall Street Journal have GDP growth going negative or below 1% in the fourth quarter of this year and the first half of next year. The economists at Wells Fargo, whom I follow quite closely, put GDP growth at about minus minus 1% for the first half of 2024 after growth of barely above zero in the fourth quarter.

The labor market may not be hot, but even as the economy slows, the ratio of job-seekers to job openings remains elevated at 1.5. That’s above the less than one needed to halt wage pressures in service activities and pull inflation down to 2%.

Staffing up for holiday shopping, Amazon is adding 250,000 warehouse and other fulfillment workers and boosting the average pay to about $20.50 per hour. The largest seasonal employer will push up wages across the e-commerce and brick-and-mortar retail sectors, and have knock-on effects for restaurants, dry cleaners and other services.

Look for rising prices for meat, vegetables, in the middle aisles of supermarkets and for public-facing services like convenience restaurants.

Voila, a slowing economy and rising inflationary pressures.

The Fed must either push the economy into a more significant recession to offset those inflationary pressures or it won’t get to 2%.

The history of these things is not encouraging.

Since World War II, the economy has endured 13 recessions and many bouts of inflation. Only once, in 1994, did the Fed accomplish a soft landing, but that episode was like an early season contest between a top-rated college football team and the Little Sisters of the Poor.

In February of that year, then-Federal Reserve Chairman Alan Greenspan started raising interest rates and ultimately pulled down consumer price index inflation, minus the volatile food and energy sectors, from 2.9% to 2.1%. But that reduction is hardly on the scale of the task that current Fed Chairman Jerome Powell faces, with core inflation having peaked at 6.5% in March 2022 and still hovering near 4%.

The International Monetary Fund examined over 100 bouts of inflation in 56 countries since the oil shocks of the 1970s and found that in only 60% of those cases, inflation was brought down within five years. Most failures involved “premature celebrations,” with inflation falling a bit and then rising again.

To get to 2% inflation, Mr. Powell will have to keep his foot on the brakes and let the economy take a dive.

• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.