This week the Federal Reserve raised interest rates by 0.75 percentage point for the third time in six months, in an effort to combat inflation. The move made investors worry more about a recession, even though Fed Chair Jerome Powell and other members of the Federal Open Market Committee (FOMC) have repeatedly expressed their desire to produce a “soft landing”—meaning, roughly, to reduce inflation without causing a recession, albeit with some slowdown in growth.
Critics have expressed skepticism that this can be done. Many economists believe that the Fed has managed a soft landing only once in 11 tries over the last 60 years, in 1994-95. History, these critics argue, says that the Fed will either raise interest rates too little and fail to defeat inflation or go too far and precipitate a recession—a “hard landing.”
Landing the economy softly is a tall order, but success is not unthinkable. The Fed has done it before.
A careful historical analysis suggests, however, that the Fed has a much more encouraging record. By my reckoning, it managed a soft landing or came close in six of the 11 cases. In the other five, it was either not trying to land the economy softly—because a hard landing was needed to crush high inflation—or its policy was overwhelmed by events out of the Fed’s control. To be sure, landing the economy softly is a tall order, but success is not unthinkable. The Fed has done it before.
The first monetary policy tightening episode to consider lasted from September 1965 to November 1966. Fighting the Vietnam War, President Lyndon Johnson was determined to have both guns and butter at the same time, pushing up both defense and nondefense government spending at a time of full employment. This created stiff inflationary headwinds that the Fed tried to resist by raising interest rates from about 4% to about 5.75%, which stabilized inflation near 3%. The rate increases did not endear Fed Chair William McChesney Martin to Johnson, who asked his attorney general if he could fire Martin. (He could not.)
Inflation started rising again in December 1967, reaching about 6% by the spring of 1969, an astounding number at the time. With fiscal policy still undisciplined, even the Fed’s sharp interest rate increases up to about 9.2% were not enough to push inflation down. Johnson tried to help the Fed by asking Congress for a tax hike in January 1967, but legislators delayed passage until June 1968, by which time aggregate demand and inflation had gathered a full head of steam.
Because inflation did not drop quickly, contemporary observers declared the anti-inflationary package—tight money plus the 1968 tax increase—a failure. But while patience was needed, inflation did finally fall a bit—down to about 5% in 1971. A mild recession began in December 1969, but since the net cumulative decline in real GDP during the 1969-70 recession was a mere 0.6%, I’d characterize it as a softish landing.
The next sharp monetary tightenings came in the 1970s and early 1980s, when inflation hit double-digit peaks around 12% in 1975 and over 13% in 1980. The Fed raised the funds rate by almost 10 percentage points from February 1972 to July 1974, by 13 percentage points from January 1977 to April 1980, and by roughly 10 percentage points from July 1980 to January 1981. Each of these interest rate cycles was followed by a recession, which may be the source of the widespread view that hard landings are the norm.
In the latter two cases, however, the hard landings were clearly policy choices, not mistakes. Paul Volcker, who became Fed Chair in 1979, wasn’t trying to land the economy softly. He insisted that double-digit inflation had to be eradicated, even if the cost was high. In the case of 1972-74, a recession was probably inevitable whatever the Fed did, given a barrage of food shocks due to crop failures and energy shocks due to OPEC.
The next important tightening episode was the yearlong cycle of rate increases from March 1988 to April 1989, which was the proverbial exception that proves the rule. By early 1988, the unemployment rate had drifted down to 5.7%, which many economists viewed as the “natural” or equilibrium rate at the time, and core inflation had perked up slightly. The FOMC decided to begin tightening, albeit ever so slowly, raising the federal-funds rate about 3.25 percentage points over 13 months.
History does not allow for do-overs, but I have long believed that this tightening cycle would have produced a soft landing were it not for the sharp spike in oil prices following Saddam Hussein’s invasion of Kuwait in August 1990. The 1990 oil shock was short, but it dashed any hopes for a soft landing and sent the U.S. into the recession of 1990-91. That was bad luck for the Fed, the economy and President George H.W. Bush’s reelection prospects. But the fault lies with Saddam Hussein, not with Alan Greenspan.
The lesson here is that external shocks can ruin the best-laid plans.
The next rate-hiking episode began early in 1994 and lasted about a year. It led to a “perfect” soft landing, often considered the only such case in U.S. history. It is also personal to me, since I was the Fed’s vice chair at the time.
When we started raising rates in February 1994, inflation was stable at around 3%, and the unemployment rate was also stable at 6.6%, which was then thought, erroneously, to be tolerably close to the natural rate. Numbers like those did not obviously call for tighter monetary policy. But with the funds rate sitting at 3% since September 1992, making the real funds rate—that is, the nominal rate minus inflation—zero, the FOMC was getting nervous about incipient inflationary pressures from loose monetary policy. It reacted by raising the target funds rate by 3 percentage points over the course of a year.
The results were fabulous. Inflation remained around 3% for two to three more years and then drifted down slightly. The unemployment rate also trended down for most of the next six years, dropping to as low as 3.8% in April 2000. Except for a short growth hiccup in the first half of 1995, real GDP rarely grew at less than a 3% annual pace for the rest of the decade. There was certainly no recession. If that’s not a perfect soft landing, I don’t know what is. But it’s important to remember that the Fed wasn’t trying to push inflation down at the time, only to stabilize it, and the central bank was lucky that its plans were not derailed by supply shocks as in 1990.
By my reckoning, the next tightening cycle began in January 1999. The FOMC’s first announced rate increase did not come until July 1999, but the effective funds rate in the marketplace had been drifting up for six months prior. One year later, when the effective rate peaked, it had risen by nearly 2 percentage points. This was a modest tightening, but along with the stock market crash of 2000, it was enough to precipitate the 2001 recession. (The 9/11 catastrophe did not seem to derail the economy.) Was that a hard landing? Not very. The two (nonconsecutive) quarters of negative GDP growth in 2001 were so small that they left GDP for the year as a whole higher than in 2000. For that reason, I have long called it the “recessionette.” Regardless of terminology, the landing was on the soft side.
It’s true that the rate increases of 2004-06 and 2015-19 were followed by extremely painful recessions in 2007-09 and 2020. “Hard” is an understatement. But these recessions were not caused by tight money. The first came from the world financial crisis and the second was a product of the pandemic.
So let’s tote up the historical score. Eliminating those final two episodes and the three tightening cycles from 1972 to 1981, when the Fed was clearly not trying for soft landings, leaves us with six tightening cycles about which to ask the key question: When the Fed tried to engineer a soft landing, did it succeed? Perhaps surprisingly, the answers are mostly yes. Of those six episodes, five landings were soft or at least softish, and the other likely would have been so were it not for the 1990 oil shock. That record says to me that while perfection is, in this and all things, hard to achieve, the Federal Reserve is not chasing a holy grail when it seeks a soft landing.
Today the Fed is in the midst of its 12th tightening cycle since the 1960s. The FOMC has just raised its funds rate target to 3-3.25% and is expected to go higher. Inflation has declined only slightly so far, and people are forgetting—as they often do—one of the key lessons of monetary history: The time lag between tighter money and lower inflation is long. The eventual landing, whether hard or soft, is out in the future somewhere.
Based on history, I’d rate the chances of a softish landing this time as well under 50% but well above zero. On the negative side, the Fed’s current task is not just to stabilize the inflation rate, as in 1994, but to bring it down substantially, as in 1980. That would be a tough job even without food and energy shocks. Unfortunately, the Fed’s luck started out bad, not good.
Furthermore, the FOMC got started late. By now, inflation has both gathered a head of steam and spread beyond the initially impacted areas such as energy, food and products plagued by supply bottlenecks. “Sticky,” and hence more stubborn, components of inflation such as rents are now running high, as are wage settlements. Some of this may reflect inflationary expectations.
On the bright side, however, those expectations still seem under control. In fact, the expected inflation rate implied by bond prices is right in line with the Fed’s target, which translates to 2.5% for the CPI. Critics concerned that expectations of high inflation are already deeply ingrained should remember that today’s inflation is still a youngster. Only 18 months ago, the core CPI inflation rate was 1.6%. Unlike Americans of the early 1980s, today’s price and wage setters don’t think of 2% inflation as something out of never-never-land. They’ve lived with it—recently. Finally, when a monetary tightening cycle starts from an unemployment rate around 3.5%, a job creation rate near 500,000 a month and record vacancies, the economy can slow down without catastrophic effects in the labor market.
History teaches us that successfully engineering a softish landing requires both skillful decisions and a dollop of good luck. But the odds are far from prohibitive.
—Mr. Blinder, a professor of economics and public affairs at Princeton, served as vice chairman of the Federal Reserve in 1994-96. His new book, “A Monetary and Fiscal History of the United States, 1961-2021,” will be published on Oct. 11 by Princeton University Press.