Soft landing

What Is Soft landing?

A soft landing in macroeconomics describes a scenario where a central bank successfully tames inflation by raising interest rates without triggering a recession. It represents a desired outcome of monetary policy aimed at slowing an overheating economy to a sustainable pace of economic growth. The term "soft landing" contrasts with a "hard landing," which implies a more severe economic downturn or recession. Achieving a soft landing is a delicate balancing act for policymakers, requiring precise adjustments to financial conditions to cool aggregate supply and demand without causing a significant contraction in output or employment.

History and Origin

The concept of an economic soft landing gained prominence in the 1970s, with former U.S. Treasury Secretary George Shultz credited with popularizing the term to describe efforts to combat inflation without causing a severe economic downturn. Historically, central banks like the Federal Reserve have attempted to engineer soft landings during periods of high inflation. One widely cited example is the period between 1994 and 1995, when the Federal Reserve, under then-Chair Alan Greenspan, aggressively raised the federal funds rate to preemptively address rising inflation. This move was followed by a moderation in inflation without a subsequent recession, leading many economists to consider it a successful soft landing.⁴,³

Key Takeaways

A soft landing is an economic scenario where inflation is reduced without causing a recession.
Central banks primarily use adjustments to interest rates as a tool to achieve a soft landing.
The goal is to slow economic activity sufficiently to curb price increases while maintaining positive economic growth and stable employment.
Successful soft landings are considered rare and challenging to execute, often depending on a combination of skillful policymaking and favorable external conditions.
It stands in contrast to a "hard landing," which involves a significant economic contraction or recession.

Interpreting the Soft landing

Interpreting whether an economy is achieving or has achieved a soft landing involves observing several key economic indicators. Policymakers and analysts look for signs that inflation is consistently trending downwards towards the central bank's target, typically without a sharp increase in the unemployment rate or a sustained decline in gross domestic product (GDP). A period of slower, but still positive, GDP growth is often considered indicative of a soft landing, as opposed to negative growth which signals a recession. The stability of consumer spending and business investment during a period of monetary tightening also offers clues to the success of a soft landing effort.

Hypothetical Example

Imagine a country, "Economia," is experiencing high inflation due to robust consumer spending and rapid economic growth. The central bank of Economia decides to implement a tightening cycle by gradually raising its benchmark interest rates over several quarters.

Initially, the higher interest rates lead to a slight decrease in borrowing for homes and businesses, cooling demand. While some sectors, like housing, see a slowdown, overall gross domestic product growth remains positive, albeit at a slower pace. The unemployment rate stays relatively stable, avoiding a significant spike. After 18 months, the annual inflation rate falls from 7% to 2.5%, close to the central bank's target, and Economia avoids a recession. This scenario would be considered a soft landing, as the central bank achieved its goal of curbing inflation without causing widespread economic hardship.

Practical Applications

The concept of a soft landing is central to central banking and monetary policy discussions, particularly during periods of rising inflation. Policymakers actively try to achieve a soft landing by carefully managing interest rates and other tools like quantitative easing to influence economic activity. For instance, recent efforts by central banks globally have focused on guiding their economies toward a soft landing by bringing down inflation while attempting to maintain robust labor markets and avoid severe downturns. Success in achieving a soft landing can have significant implications for financial markets, impacting investor confidence and asset prices across various classes. Economists analyze historical business cycle data and central bank actions to better understand the conditions that facilitate or hinder a soft landing.

Limitations and Criticisms

Achieving a soft landing is notoriously difficult and widely considered a rare occurrence in economic history. Critics often point out that the ability of a central bank to perfectly calibrate monetary policy to slow an economy without causing a recession is highly challenging. Many factors influencing the economy, such as global events, geopolitical tensions, and shifts in fiscal policy, are beyond the direct control of central banks. Some analyses suggest that past "soft landings" might have been as much a result of good fortune or external factors as they were of skillful policy management. For example, during the 1994-1995 tightening cycle, while the U.S. economy avoided a recession, the rapid increase in interest rates did create ripple effects that contributed to financial distress in other parts of the world, such as the Mexican peso crisis.² The European Central Bank also notes that only about one-third of past monetary policy tightening cycles have ended in soft landings, highlighting the inherent difficulty.¹

Soft landing vs. Hard landing

The primary distinction between a soft landing and a hard landing lies in the outcome of a central bank's efforts to cool an overheating economy. A soft landing occurs when the central bank successfully reduces inflation and moderates economic growth to a sustainable pace without triggering a recession or a significant rise in unemployment. Economic activity slows, but remains positive, and the labor market remains relatively strong. In contrast, a hard landing describes a scenario where the central bank's tightening of monetary policy is too aggressive or the economy proves too fragile, leading to a sharp downturn, widespread job losses, and a formal recession. While a soft landing is the preferred outcome, a hard landing represents the significant risk associated with attempts to curb high inflation.

FAQs

What causes a soft landing?

A soft landing is typically caused by a central bank's successful implementation of monetary policy (usually through raising interest rates) to bring down inflation without triggering a recession. It requires precise timing and calibration of policy tools.

Why is a soft landing desirable?

A soft landing is desirable because it allows an economy to stabilize prices and avoid the significant negative consequences of a recession, such as widespread job losses, declining corporate profits, and increased financial instability. It represents a transition to more sustainable economic growth.

How rare are soft landings?

Soft landings are considered rare. Many economists and historical analyses suggest that achieving a true soft landing is difficult, often dependent on favorable external factors in addition to skillful monetary policy. The 1994-1995 period in the U.S. is frequently cited as a notable example.

What are the main challenges in achieving a soft landing?

The main challenges include the time lag between policy actions and their economic effects, unforeseen economic shocks (like supply chain disruptions or geopolitical events), and the difficulty in precisely gauging the economy's resilience to higher interest rates. These factors make the path to a soft landing uncertain.