Gliding To A Soft Landing?

Modern economics makes itself intelligible by adopting everyday analogies. If inflation worsens, we say the economy is "overheating." If the Federal Reserve raises interest rates, it's "applying the brakes." If it cuts rates, it's "stepping on the gas." The metaphor of the moment is "soft landing." The economy slows enough to avoid higher inflation but not so much that it suffers a "hard landing" (a recession). It's an enticing vision which may or may not come true.

The trouble with these analogies is that, even as they clarify, they oversimplify. The case for a "soft landing," though plausible, may not come true because the economy is not an airplane and Alan Greenspanchairman of the Federal Reserve Boardis not its pilot.

The main difference involves control. Pilots have a lot of it. Landing and takeoffs are routine. By contrast, the Federal Reserve tries to steer the nearly $10 trillion U.S. economy through one tiny instrument: the obscure Fed funds rate. This is the interest rate on overnight loans between banks. When the Fed funds rate moves, the ripple effects spread to other short-term rates (on home-equity loans, business loans), long-term rates (on mortgages, bonds), exchange rates, the stock market and popular psychology. But the connections aren’t always the same or entirely predictable.

To shift analogies: the Fed has a small lever (the Fed funds rate) to move an immense boulder (the economy).

Confidence in the "soft landing"; stems from the current boom which has consistently defied pessimistsand a fervent faith in Greenspan. His record surely warrants respect. The economic expansion, now in its 10th year and the longest in U.S. history, has already experienced one “soft landing.” Between February 1994 and February 1995, the Fed funds rate went from 3 percent to 6 percent. Some economists feared a recession. It never came.

Greenspan prides himself on acting pre-emptively: judging economic conditions and altering rates to prevent major problems. After Asia's financial crisis in 1997 and 1998, the Fed cut rates. Beginning in June 1999, it started raising them again on the theory that the boomif unrestrainedwould create inflationary wage and price pressures. Sure enough, these seemed to appear in early 2000. Through May the consumer price index has risen at an annual rate of 3.6 percent, compared with a 2.7 percent rise for all of 1999. The employment cost indexa measure of labor compensationincreased 4.3 percent for the 12 months ending in March. A year earlier, the gain was only 3 percent.

But right on schedule, it seems, the slowdown arrived:

*Retail sales—everything from food to carsdropped in April (0.6 percent) and May (0.3 percent).
*In May the unemployment rate inched up to 4.1 percent from 3.9 percent, and private-sector jobs declined by 116,000.
*Housing construction has weakened, with new-home starts in May at an annual rate10 percent lower than in December.

"Consumers have been on such a spending binge that while they say it's a good time to buy a car or house, they've already bought a car or house," says economist Cynthia Latta of Standard Poor's DRI. "And if you're not building as many new homes, you don't need as many new appliances."

The economy seems to be landing softly. But could this picture be wrong? Well, yes.

For starters, the slowdown might be a mirage--a "temporary payback" for the rapid growth of late 1999 and early 2000, says economist Ira Kaminow of the Capital Insights Group. In the last three months of 1999 the economy grew at an astounding annual rate of 7.3 percent. People may have bought in December what they would have bought in May. Once this effect wears off, the economy may resume growing at more than 4 percentfaster than the Fed wantsand require further interest-rate increases. (Since mid-1999, the Fed has raised the Fed funds rate from 4.75 percent to 6.5 percent. It next considers interest rates at a meeting June 27 and 28.)

Or the slowdown might prove worse than expected. "Lower-income household debt is very high," says Mark Zandi of Regional Financial Associates. "That may be the economy's Achilles' heel." Even in 1998, about a fifth of households with incomes of less than $50,000 needed 40 percent or more of their after-tax income to pay interest and principal on debt, he reports. Higher gasoline prices are another possible problem. They could depress consumer confidence and spending, says Susan Sterne of Economic Analysis Associates. Jobs, profits, the stock market and corporate investment could suffer.

None of these economists yet predicts a recession. In the Standard Poor's DRI outlook, the economy grows nearly 5 percent in 2000 and slows to 3 percent in 2001. Unemployment hovers around 4 percent. As slowdowns go, that's spectacularly benign. On the other hand, forecasters have often missed major economic turning points.

Everyone is dealing in educated hunches. The imagery of a "soft landing" promotes a false sense of mastery. Pilots know how far and fast their planes can fly. With radar, they have a good sense of weather and terrain. Our economic vision is more clouded. Statistics and studies give incomplete or conflicting answers about current conditions (say, inflation) and the economy's potential growth rate.

The larger point is that the economy responds to its own rhythms: new technologies, products, popular moods, management practices, government policies. The Fed is only one influence, although an important one. In the 1960s and 1970s, the metaphor of choice was "fine tuning." Government could sustain "full employment,"'; it was said, by tweaking various policy dials--taxes, spending, interest rates. The effort failed notably. This history is worth recalling, because it suggests that today's hyperconfidence could usefully be accompanied by some humility.