The Myth of the Central Bank ‘Soft Landing’

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Most tight cycles have historically ended in recessions. Whether it shows the power or powerlessness of central banks is not good news.

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Consumer sentiment indicators are falling in most developed countries. After data for US inflation reaching 8.6% in May, inflation expectations actually dipped further a few years down the road. Stocks have fallen into a bear market, and investors have given up on the notion of a more aggressive Fed that is bringing inflation down without hurting growth — the famous “soft landing.”

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He has an empirical point: being generous, is a rare occurrence.

Nine of the Fed’s last 12 major tightening cycles since the 1950s ended in recession, official figures show. In exceptions, rates rose steadily between 1961 and 1966 without any fall, but inflation only temporarily subsided, and eventually led to a recession in 1970. Perhaps the most successful soft landings were in 1983 and 1984, although the economy had just recovered from two recessions. And then there’s the cycle from 1994 to 1995, where inflation didn’t increase at all: Alan Greenspan’s Fed acted for no apparent reason other than to validate bond market forecasts.

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The BOE has a better track record, but almost half of its rate-raising campaigns since the 1950s still ended with the UK recession.

Investors struggle to measure this risk because Central bankers don’t seem to have a coherent theory How are they supposed to micro-manage inflation? Modern ideas are more suited to the optimistic view that the economy can be slowed in a “nominal” sense without affecting employment or inflation-adjusted wages. They often focus on how the psychology of inflation expectations can govern pricing in the present. But it has weak support in the data.

Indeed, executives often appear to back away from 1960s-style interpretations, seeing labor market cooling as a necessary step. For example, Fed Chairman Jerome Powell recently described this as “an unhealthy level”, while BOE Gov. Andrew Bailey stressed the need for wage restraints.

If monetary policy works, something needs to be given – whether it’s weak credit growth, low asset prices or a gloomy business environment. This can happen without affecting one’s “real” physical conditions, is wishful textbook thinking.

To be sure, the power of interest rates on unemployment should also not be underestimated. Yes, there is a historical coincidence between monetary and business cycles, but it is only natural: as economies flourish, officials raise rates, only to halt when a recession strikes. The experience of the mid-1990s is a rare case of monetary tightening without a tight economy, and the effect was limited.

The overall perception is that extreme rate moves as in the 1970s and 1980s are likely to have a meaningful impact. Even if central bankers manage to make the right amount of change in the beginning, it will only correct the small component of today’s inflation which is not commodity-driven. Headline numbers will remain high, creating an irresistible pressure on officials to maintain strictness.

Investors had better hope that the soft landing would happen spontaneously, as the engineering prospects for central banks did not look good.

John Sindreu [email protected] . Feather

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