The Federal Reserve’s push to slow the economy and rein in inflation is often compared to the descent of an airplane, one that could end in a soft landing, a rough landing, or a total crash.
Jerome H. Powell, the Fed chairman, is betting on something akin to the Miracle on the Hudson: a touchdown that is soft, all things considered, and unlike anything the nation has seen before.
The Fed has raised rates sharply over the past year, taking them to just above 5 percent on Wednesday, in an attempt to cool the economy to control inflation. Central bank economists have begun forecasting that the United States is likely to tip into recession later this year, as major policy moves by the Fed combine with turmoil in the banking sector to stifle growth.
But Powell made it clear during a news conference on Wednesday that he disagrees.
“That’s not my most likely case,” he said, explaining that he expects modest growth this year. That more optimistic forecast has depended, in part, on trends in the labor market.
The US labor market remains very strong, with rapid job growth and unemployment floating near a 50-year low, but has shown signs of cooling. Job openings have declined dramatically in recent months, falling to 9.6 million in March from a peak of more than 12 million a year earlier. Historically, such a massive decline in the number of available positions would have been accompanied by layoffs and rising unemployment, and prominent economists had predicted a painful economic landing for precisely that reason.
But so far, unemployment hasn’t budged.
“It wasn’t supposed to be possible for job openings to go down as much as they have without unemployment going up,” Powell said this week. While the United States will get the latest update on unemployment when a labor market report is released on Friday, unemployment has yet to rise significantly.
Mr. Powell added that “there are no promises here, but it seems to me that it is possible that we could continue to have a cool down in the labor market without having the large increases in unemployment that have occurred in many previous episodes. ”
The economic fate of the United States depends on whether Powell’s optimism is correct. If the Fed can pull it off, defying history to fight rapid inflation by dramatically cooling the job market without causing a large and painful rise in unemployment, the legacy of the post-pandemic economy could be tumultuous but ultimately , positive. If he can’t, reining in price increases could come at a painful cost to American employees.
Some economists are skeptical that the good times can last.
“We haven’t seen this offset, which is fantastic,” said Aysegul Sahin, an economist at the University of Texas at Austin. But he noted that the productivity data looked grim, suggesting that companies were burned by years of pandemic labor shortages and are now holding on to workers even when they don’t necessarily need them to produce goods and services.
“This time it was different, but now we are going back to the state where there is a more normal job market,” he said. “This is going to start playing out the way it always does.”
The Fed is in charge of encouraging both maximum employment and stable inflation. But those goals can conflict, as is the case now.
Inflation has been above the Fed’s 2 percent target for two full years. While the strong labor market did not initially cause the price spikes, it could help perpetuate them. Employers are paying higher wages to try to hold on to workers. While they are doing that, they are raising prices to cover their costs. Workers who earn a little more can afford rising rents, childcare costs and restaurant checks without going backwards.
In situations like this, the Fed raises interest rates to cool the economy and the job market. Higher borrowing costs slow down the housing market, discourage big consumer purchases like cars and home improvement projects, and deter businesses from expanding. Because people are spending less, companies can’t keep raising prices without losing customers.
But getting policy right is an economic tightrope act.
Policymakers believe that acting decisively enough to bring inflation under control quickly is paramount: if allowed to linger too long, households and businesses could expect prices to rise steadily. They could then adjust their behavior, asking for larger increases and normalizing regular price increases. That would make inflation even more difficult to eradicate.
On the other hand, officials do not want to cool the economy too much, causing a painful recession that will prove more severe than necessary to bring inflation back to normal.
Striking that balance is a risky proposition. It’s not clear exactly how much the economy needs to slow down to fully control inflation. And the Fed’s interest rate policy is blunt, imprecise and takes time to work: it’s hard to guess how much the increases so far will ultimately weigh on growth.
That’s why the Fed has slowed its policy changes in recent months, and why it seems ready to stop them altogether. After a series of three-quarter point rate moves last year, the Fed recently adjusted borrowing costs one quarter point at a time. Officials signaled this week that they could stop raising rates altogether as soon as their mid-June meeting, depending on incoming economic data.
Pausing would give central bankers a chance to see if their rate adjustments so far might be enough.
It would also give them time to assess the consequences of the turmoil in the banking industry, turmoil that could make an economic soft landing even more difficult.
Three big banks have collapsed and required government intervention since mid-March, and jitters continue among midsize lenders, with shares of several regional banks tumbling on Wednesday and Thursday. Banking problems can quickly translate into economic problems as lenders pull out, leaving businesses less able to grow and families less able to finance their consumption.
The job market could see a more dramatic slowdown, given the banking turmoil and the Fed’s rate moves so far, said Nick Bunker, director of North American economic research at job site Indeed.
He said that while job openings have been dwindling rapidly, some of them could reflect a return to normal conditions after a pandemic-inspired bout of weirdness, not necessarily as a result of Fed policy.
For example, job postings in the leisure and hospitality industries skyrocketed as restaurants and hotels reopened after lockdowns. Those were now disappearing, but that might be more about a return to business as usual.
“There’s a soft landing happening, but how much of that is gravity and how much of that is what the pilot is doing with the plane?” said Mr. Bunker. Going forward, it could be that the normal historical relationship between declining job openings and rising unemployment kicks in as politics kicks in.
Or this time could be truly unique, as Powell hopes. But whether the Fed and the US economy succeed in testing his thesis could depend on whether the problems in the banking system are resolved, Bunker said.
“We may not get the answer if the financial sector comes in and turns the table over,” he said.