Wide-leg jeans, butterfly clips, and half-point increases: the 1990s are back.
Earlier this month, Federal Reserve Chairman Jerome Powell announced a 0.5 percentage point increase in interest rates, the largest increase in more than 20 years. Powell also said he would not hesitate to do it again — a direct departure from the central bank’s 1994 playbook, when the Fed eased the U.S. economy one last time and successfully executed a so-called soft landing.
In the 12 months after February 1994, the Fed, under former Chairman Alan Greenspan, nearly doubled interest rates to 6% in just seven hikes, including Two half-point hikes and one three-quarters hike.
“Eat your heart, 1994,” Morgan Stanley analysts wrote in a note following Powell’s comments.
Inflation is near a 40-year high, and most economists agree that the Fed should raise interest rates to reduce demand in the economy and keep prices stable. They just don’t agree on what that means for the economy as a whole.
The history of central bank rate hikes does seem to support the inevitability of recessions, but soft landings by the Fed are rare: once in 1965, and once in 1984 and 1994.
Over the next few months, the Fed will try to cool the economy, leading to lower prices but not a recession. It’s some Goldilocks mission, Including former New York Fed President Bill Dudleybelieved to be almost impossible to implement.
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Powell’s leading critic of the Fed, Larry Summers, sees a 100% chance that the Fed will act to result in a hard landing. Analysts at Goldman Sachs said the odds were closer to one in three.
But Powell remains convinced that 1994 brought us more than just reruns of The Lion King and Ace of Base.
“I believe the historical record provides some reason for optimism: Soft landings, or at least soft landings, are relatively common,” Powell said in a statement. March speech.
But there are some major differences between 1994 and 2022, and timing is probably the most important factor.
Greenspan took the initiative to raise interest rates. He sees the economy booming and wants to stay ahead of inevitable inflation. Powell reacted more strongly. He raised rates by half a percentage point only after inflation soared to levels not seen in decades. The Fed may be far behind the curve and unable to ease inflation without causing economic hardship for Americans.
Employment today is not what it was then. In 1994, Baby Boomers were at the peak of their careers, a slew of new technologies were being introduced into the workplace, and immigration was high. All of this has resulted in a huge workforce and productivity, with unemployment remaining low even as interest rates rise. In 2022, we face baby boomers preparing to exit the workforce, a significant drop in labor force participation due to the pandemic, and slowing productivity.
“In the past, when you pushed up unemployment, you almost never avoided a full-blown recession,” Dudley said. “The problem with the Fed is that they are late.”
Geopolitical luck was also a factor in the soft landing of ’94, and despite the best efforts of economists, luck was not easily replicated.
The North American Free Trade Agreement (NAFTA) was passed in 1994, just five years after the Berlin Wall fell. Both of these things increase the supply of imports and reduce the cost of goods. Today, globalization is going backwards as the pandemic and war in Ukraine have caused wild swings in energy prices and disrupted supply chains.
Carl Tannenbaum, chief economist at Northern Trust, wrote in a research note: “On closer inspection, the Greenspan Fed has benefited from considerable good fortune that the incumbent Fed is unlikely to enjoy. Good luck.” “That’s not to say this soft landing is impossible. But it’s a lot more difficult than it was 28 years ago.”
There may still be room for a soft landing, as long as you’re willing to tweak the definition a bit. Since 1965, we’ve seen the Fed tighten policy 11 times (excluding the current move), Princeton economist Alan Binder says. Seven of these resulted in a fall in economic production of less than 1%, a relatively small decline. “So a soft landing is not that difficult to achieve,” he concluded.
After all, a soft landing might be the best outcome we could hope for.