Soft Landings Are Hard

Chief Economist Scott Brown discusses current economic conditions.

In a speech to the National Association for Business Economics, Fed Chair Powell said that “if we conclude that it is appropriate to move more aggressively by raising the federal funds rate by more than 25 basis points at a meeting or meetings, we will do so.” He added that “and if we determine that we need to tighten beyond common measures of neutral and into a more restrictive stance, we will do that as well.” Powell had said the same thing during his March 16 press conference. At issue is the notion of a “soft landing,” where economic growth slows to a more sustainable pace consistent with a strong job market and low inflation. Powell appeared to be optimistic that the Fed can make that happen.

A year ago, when inflation began to pick up, the Fed was not very concerned. Price increases were narrow, confined to a limited number of sectors where prices had been depressed by the shutdown of the economy a year earlier. By the summer of last year, price increases had begun to broaden across categories, reflecting supply chain issues and a sustained increase in the demand for goods. Fiscal policy support in 2021 (direct deposits to individuals in January and March, expanded unemployment benefits, and child tax credits) boosted disposable income. The Fed expected that the absence of this support in 2022 would lead to slower growth in consumer demand and inflation would decline. The situation in Ukraine has further boosted oil prices. Higher gasoline prices will add significantly to the March CPI (due April 12).

While wage growth has picked up, real average hourly earnings have declined. Personal income should post a strong gain in February (to be reported March 31), led by growth in aggregate wage and salary income, but not enough to outpace inflation. Real personal income is the primary driver of consumer spending growth.

Motor vehicle sales and housing have traditionally been viewed as the canary in a coal mine. Weakness is an early sign of recession. However, both sectors remain supply constrained. Motor vehicle production is still restrained by shortages of parts (especially, semiconductors), but there is plenty of demand. Similarly, shortages of labor and materials are limiting housing construction. Higher home prices and rising mortgage rates have further reduced housing affordability, but demand appears to have remained relatively strong. Note that vehicle and home sales decline in a recession, and pent-up demand helps to fuel a strong recovery when the recession comes to an end. Ongoing supply constraints will make it difficult to gauge the impact of monetary policy, which may be a key reason for the Fed to be cautious as it raises short-term interest rates.