A History of Soft (and Hard) Landings in the Fight Against Inflation
The Fed has been raising interest rates aggressively to fight inflation while seeking to avoid a recession. But what's its track record for sticking the landing?
In its fight against inflation, the Federal Reserve (Fed) aims to achieve a soft landing, where the economy cools down just enough and avoids a recession.
Hard landings—when the Fed reins in the economy too much or fails to control inflation—could lead to a recession and/or high unemployment.
Given continued uncertainty about the economy and inflation, we expect market volatility to continue.
In the fight against inflation, the Federal Reserve (Fed) aims to achieve a soft landing, whereby the economy cools down just enough but not so much that it enters a recession. There is skepticism, even from the Fed Chair himself, Jerome Powell, that the central bank will be able to pull this off. However, Powell believes a soft landing is still possible. He points to the history of soft and hard landings to explain the Fed’s current inflation-fighting strategy.¹
Here is a look at how the Fed has used monetary policy to reduce and control inflation and the lessons this history holds for investors today.
How Does the Fed Control Inflation?
The Fed seeks to keep the U.S. economy healthy and stable through a dual mandate: 1) targeting stable prices—a core inflation rate averaging 2% over the long term—and 2) maximizing employment.
In December 2022, the annual headline inflation rate, as measured by the Consumer Price Index, was 6.5%.² Although inflation has fallen from a peak of 9% in June—the highest levels since the 1980s—its current level remains out of line with the Fed’s mandate. Therefore, policymakers continue to maintain a tight monetary policy.
The Fed’s primary means of tightening monetary policy is by increasing the federal funds rate. This is the rate banks charge each other for overnight loans. From mid-March to its last hike in 2022 on December 14, the Fed hiked the federal funds rate seven times, lifting it from a range of 0%-0.25% to 4.25%-4.5%.
How do increases in the federal funds rate transmit through the economy? It tends to slow down economic activity by decreasing the money supply, i.e., the amount of money in circulation in the U.S.
When borrowing costs rise, banks require their customers to pay more for loans. Therefore, Fed rate increases indirectly affect all consumer loans, including mortgages. Some consumers may no longer be able to afford the higher mortgage payments and cannot purchase a home. A slowdown in the mortgage and housing markets has implications for many sectors of the economy.
Here is a simplistic view of how interest rate increases aim to reduce economic activity and decrease inflation.
- Interest Rates
in order to
Demand for Goods and Services
Soft Landings vs. Hard Landings
While policymakers hope their efforts will generate a soft landing, sometimes they overshoot, resulting in a hard landing.
A soft landing occurs when the Fed restores its dual mandate without triggering a recession.
A hard landing occurs when monetary policy reins in economic activity too much or fails to control inflation, leading to a recession and/or high unemployment.
The Fed has a lot to think about when tightening monetary policy to reduce inflation:
Interest rate increases affect other areas, such as asset prices, markets and exchange rates, which may in themselves bring adverse effects.
Consumers’ expectations of inflation may contribute to inflation becoming entrenched—or sticky—and more challenging to reverse with monetary policy.
There is a time lag between the implementation of policy changes and when the economy feels the effects of those changes.
As a result, the Fed holds meetings throughout the year to determine its next move, raising interest rates in steps. It also looks to lessons learned from its past actions as a guide for addressing current challenges.
History Shows a Mixed Bag of Soft and Hard Landings
The Fed is currently engaged in its 12th episode of tightening economic policy since the 1960s. How did it fare in the last 11 cycles?
Inflation and Interest Rates History Since 1965
Source: Bloomberg. Data from 1/31/1965 to 12/31/2022.
Policymakers today want to avoid repeating the 1970s, when high inflation became entrenched. The Fed sporadically raised interest rates in an attempt to break inflation and then quickly cut rates when it thought the economy slowed too much and in some cases fell into a recession.
Now after treating inflation as “transitory” through early 2022, the Fed is making up for lost time with bold rate increases in hopes of influencing expectations.
“The public’s expectations about future inflation can play an important role in setting the path of inflation over time,” according to Powell.
3 History Lessons Guiding the Fed
In its communications regarding its current tightening policy, the Fed highlights these lessons:
1. Soft landings are possible.
Alan Blinder, former vice chair of the Fed, states policymakers managed a soft landing (or came close) six times. Policymakers did so by getting ahead of inflation while preventing unemployment from rising meaningfully. Blinder's analysis considers mild recessions and external events out of the Fed's control, such as wars and pandemics.³
Although economists have different opinions on the Fed’s track record, they generally agree with Blinder that the period from 1994-1995 was the "perfect" soft landing. The inflation rate was at 3% and unemployment was stable, but the real funds (the nominal rate minus inflation) was 0%. Fed officials were worried inflationary pressures were building and, therefore, raised the target rate by three percentage points over the course of a year and the country avoided a recession.
2. Getting ahead of inflation is critical.
The Fed likens today to the inflationary periods faced in 1974 and 1983. In 1974, the Fed did not immediately alter monetary policy, allowing high and variable inflation to take hold for a decade. Conversely, in 1983, the Fed raised rates significantly and kept them relatively high, even as inflation declined. The end result was a return to inflation below 5%.
James Bullard, president and CEO of the Federal Reserve Bank of St. Louis, explains, “The lesson from these two different approaches to monetary policy is the importance of staying ahead of—rather than getting behind—inflation.”⁴
3. Keep at it until the job is done.
The lengthy period of very restrictive monetary policy in the early 1980s ultimately broke double-digit inflation rates. Under Chair Paul Volcker, the fund rate got as high as 20%, and despite a recession, the rate wasn’t cut until inflation meaningfully declined. Notably, inflation generally remained under control until recently. The current tightening campaign suggests the Fed is following this lesson from history and staying the course.
What Does the Fed’s Monetary Policy to Reduce Inflation Mean for Investors?
The Fed wants confirmation that inflation is moderating and stabilizing. Only time will tell if the economy experiences a soft or hard landing. Given the uncertainty, expect market volatility to continue.
Being mindful of inflation's effect on your financial goals is key. We suggest investing for your long-term goals in a well-diversified mix of asset classes appropriate for your goals and risk tolerance.
To maintain growth potential, consider investments in quality companies that may benefit from secular—rather than cyclical—trends and that have solid balance sheets. Interest rate-sensitive sectors, such as housing, remain vulnerable.
Professionally managed asset allocation portfolios offer a mix of funds covering multiple asset categories in a single product—some even include Treasury inflation-protected securities. More important, fund managers will carefully select and monitor the investments in these portfolios for their shareholders.
Federal Open Market Committee (FOMC) Press Conference, November 2, 2022.
Consumer Price Index Summary, U.S. Bureau of Labor Statistics, November 2022.
Blinder, Alan. (2022) A Monetary and Fiscal History of the United States, 1961–2021. Princeton University Press.
Bullard, James. Getting Ahead of U.S. Inflation: A Lesson from 1974 and 1983. June 28, 2022.
Diversification does not assure a profit nor does it protect against loss of principal.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Investments in fixed income securities are subject to the risks associated with debt securities including credit, price and interest rate risk.
In certain interest rate environments, such as when real interest rates are rising faster than nominal interest rates, inflation-protected securities with similar durations may experience greater losses than other fixed income securities. Interest payments on inflation-protected debt securities will fluctuate as the principal and/or interest is adjusted for inflation and can be unpredictable.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.