In order to engineer a soft landing that tames inflation without tipping the economy into recession the FED needs 3 things: time, skill and luck.
1. Time
The clock is ticking and it looks like the Fed is running out of time. The FED has been far behind the curve when taking first action. When inflation is elevated for that long, inflation expectations rise as consumers grow accustomed to sharp price increases. In turn, those consumers begin to demand wage increases to cover higher prices. And then businesses raise prices to offset higher labour costs. This is the classic vicious cycle called wage-price spiral. When this happens, it can quickly become too late to control inflation with moderate policy measures that don’t lead the economy into a recession.
Additionally, monetary policy has a response lag. It can take 12-18 months for the economy and inflation to respond to interest rate hikes.
2. Skill
A skilfully lead central bank can combine multiple measures to effectively end that vicious wage-price spiral. These measures include
– raising short-term interest rates,
– reducing the amount of money in the economy by selling bonds (quantitative tightening)
– through forward guidance to reassure consumers, workers and financial markets that it has matters under control.
The Fed is struggling on all of this at the moment. It started raising interest rates too late, has been to slow sell the bonds on its balance sheet (only $25B instead the reduction target of $95B) and communicated badly and foolishly, stating all over again that inflation would only be transitory and short lived. With inflation still running at the highest level in decades, that is not true and it is becoming clear that this particular Federal Reserve may lack the skills needed to tame inflation and engineer a soft landing.
3. Luck
No time left and no skills. That leaves us with nothing than hopes on luck.
Not a great outlook. Is the FED lucky? Time will tell but I wouldn’t bet on it.
Sven Franssen