Can we really have a soft landing?

In August 1982, I arrived in Washington to begin a year on the White House Council of Economic Advisers.

Yes, it was the administration reagan and I was already liberal.

But it was a technocratic position rather than a political one, and the new Prime Minister, Martin Feldstein — a moderate Republican of a type who has since largely disappeared — he wanted brainiacs to deal with the data.

I had to focus on cinternational issues;

the new head of the national economy was a boy named Larry Summers.

What happened to him?

Anyway, Marty and I had a business dinner the night I got here, and he had a big question to ask:

“Is the world economy about to collapse?”.

There were two main reasons for his concern.

One was that Mexico it had just announced that it was unable to continue paying its debts, marking the beginning of the Latin American debt crisis.

The other was that the efforts of the Federal reserve to fight the inflation had sent the US economy into a tailspin, experiencing its worst recession since the 1930s, which would be unrivaled until the 2008 financial crisis.

But it turned out that the world economy did not collapse.

The debt crisis has produced a “lost decade“in Latin America, with widespread economic suffering, but it has not spread to become a global contagion.

And further north, a round of 180 degrees in Federal Reserve policy ended up causing a rapid recovery; in 1984 ronaldo reagan he boasted of “tomorrow in America”.

However, the memory of that summer makes me a little nervous about the economic optimism that seems to be rampant right now, at least in the media.

Predictions of a proliferation “soft landing“, i.e. a drop in inflation to acceptable levels without a recession.

And my prediction is indeed one of a soft landing:

Inflation appears to be coming down, and while we can’t completely avoid a recession, if we do, it will likely be mild.

But the experience of the early 80s continues to offer two reasons for the Attention.

First of all, controlling inflation in the 1980s was extremely painful.

Inflation has dropped from 10% to 4%.

But the disinflation process has resulted in a huge and sustained rise in unemployment.

In the economic jargon of the time there was a very high sacrifice ratio.

In late 1984, when Reagan was talking about how big the economy was, the unemployment rate was more than double of the current

Some speak as if we are faced with a similar test again.

At least until a few months ago, Summers envisioned disinflation scenarios similar to those of the 1980s, arguing that unemployment would have to rise to around 6% to control inflation.

I think you are wrong.

The distortions Pandemic-related have made it much more difficult to estimate core inflation, to the point where we’re not even sure what the term really means, but many of the measures that have been devised in an attempt to cut through the fog are showing a moderate inflation although we have yet to see a rise in unemployment.

Inflation has already declined substantially, yet again, without a sharp rise in unemployment.

So like I said, I think Larry is too pessimistic.

But am I sure?

Obviously not.

The other reason the experience of the 1980s still weighs on me is that in 1982 it was clear that the Federal Reserve had held back more than it intended.

That is, he was trying to slow the economy – in fact, he had deliberately caused a recession – but he didn’t intend to cause such a severe recession.

The truth is that then, as now, policy makers sought to manage the economy with limited informationa, often out of date, and using very imprecise tools.

Specifically, the Federal Reserve tries to reduce inflation by slowing the economy, which it in turn does by raising interest rates.

But there is intense debate about how much the economy needs to slow down, how much rates need to go up to reach a certain slowdown, and how long it takes for rate hikes to take full effect.

Sometimes I think of the Federal Reserve trying to operate heavy machinery in a dark room and wearing thick oven mitts.

So even if we don’t need a major recession to control inflation, we could still have one if the Federal Reserve slows down too much.

There is, of course, the opposite risk:

that the Federal Reserve is doing too little and inflation is not being controlled.

But I think the inflation news has been good enough to justify taking that risk and avoiding rate hikes, at least for a while.

In short?

A soft landing is now much more plausible than it seemed a few months ago.

But that’s not a fact.

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