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1 1 (December 11, 2023)

handle is hein.crs/govenqw0001 and id is 1 raw text is: Congressional Research Service informing the legislative debate since 1914 0 December 11, 2023 Has the Federal Reserve Achieved a Soft Landing in 2023? Since the Federal Reserve (Fed) began raising rates in response to high inflation in March 2022, it has been trying to achieve a soft landing-a return to low inflation while maintaining moderate economic growth. By contrast, a majority of private sector economists had, until recently, predicted that the Fed's actions would result in a hard landing-a recession-in 2023. Achieving a soft landing after sustained monetary policy tightening is notoriously difficult. Historically, most periods of sustained tightening have been followed by recessions. Nonetheless, the recent period of monetary policy tightening has so far resulted in falling inflation without a decline in employment or economic activity. If inflation reaches the Fed's target of 2% without a recession, a soft landing will have been achieved. This In Focus looks at whether a hard landing has been avoided or merely postponed. (For information on how recessions are declared and defined, see CRS In Focus IF10411, Introduction to U.S. Economy: The Business Cycle and Growth.) Recent Monetary Tightening Throughout much of 2021 and 2022, inflation persistently rose to levels not seen in the United States since the 1980s. (See CRS Report R46890, Inflation in the Wake of COVID- 19.) To reduce high inflation, the Fed raised short-term interest rates from a range of 0%-0.25% to a range of 5.25%-5.50% between March 2022 and July 2023 (see Figure 1). The Fed has not ruled out further rate increases depending on the future path of prices and other economic data. The Fed is statutorily mandated to maintain low and stable prices-which it defines as 2% inflation, as measured by the personal consumer expenditures price index (PCE)- and maximum employment. Monetary policy tightening (higher interest rates) works to reduce aggregate demand (total spending) in the economy, which can reduce inflationary pressures but can also result in rising unemployment, often leading to recession. In theory, it would be difficult for monetary tightening to generate a large reduction in inflation without a significant economic slowdown. For more information, see CRS In Focus IF11751, Introduction to U.S. Economy: Monetary Policy. History of Hard and Soft Landings Historically, periods of similarly rapid and substantial interest rate increases have resulted in recession (see Figure 1). Some of the more obvious parallel periods, in terms of starting inflation rate and magnitude of rate hikes, are recessions during the so-called Great Inflation of the late 1960s to the early 1980s. (Not all recessions have been direct results of monetary tightening. For example, the 2020 recession was a direct result of the COVID-19 pandemic and its effects on economic activity.) Not every monetary tightening has resulted in a recession. Fed Chair Jerome Powell has pointed to soft landings after monetary tightening in 1965, 1984, and 1994. Those episodes were arguably less challenging than the current one, however. They featured smaller cumulative rate increases than this most recent period of tightening because inflation was already low in 1965 and 1994 and below 5% in 1984. A recent study of historical soft and hard landings found, If the need to fight inflation is not too extreme, and serious adverse events like wars or supply shocks do not intervene, the Federal Reserve has shown itself capable of engineering a landing that either does not induce a recession or, if it does, induces a small one. It has done so several times. Figure I. Federal Funds Rate and Inflation January I 960 to September 2023 Feal FundssRate P cd Source: Federal Reserve, Bureau of Economic Analysis. Why is a Soft Landing Possible? By many measures, the economy looks like it is headed for a soft landing. Despite a recent pause in rate increases, inflation has continued to fall. PCE was unchanged in October 2023 for the month, and the 3.0% year-over-year increase was the lowest rate since March 2021. There are signs that the labor market is not as tight as it was last year: For example, the unemployment rate rose from 3.4% in April 2023 to 3.9% in October 2023 (before falling to 3.7% in November), and job growth over the last 12 months has fallen to a more sustainable rate-a little more than half the previous 12 months (see Figure 2). How was the Fed able to raise rates rapidly and by a large magnitude without triggering a hard landing? Why were the predictions of a majority of economists incorrect? One explanation is that the labor market has tightened some as predicted following monetary tightening-but because unemployment started at such low levels, the rise has so far not resulted in the high levels that one would associate with a recession. (The lowest peak unemployment rate in a U.S. recession since World War II is 6.1%.) Historically, periods of low unemployment (below 4%, for example) were associated with rising inflation. Based on this phenomenon,

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