Way back in 1973, America was experiencing a troubling rise in inflation. But George Shultz, the Treasury secretary at the time, suggested that the problem would be transitory — that the economy could have a “soft landing.”
It didn’t. The 1970s were infamously a decade of stagflation, and inflation was finally brought under control in the 1980s only via tight money policies that caused years of very high unemployment.
So President Biden was tempting fate a bit when he declared in the State of the Union address that “the landing is and will be soft.” But he’s almost surely right.
What do we mean by a soft landing? Broadly speaking, achieving acceptably low inflation without high unemployment. But what do we mean, specifically, by low inflation and low unemployment? Back in October 2022, Harvard’s Jason Furman — a soft-landing pessimist at the time — laid out some specific, if somewhat arbitrary, criteria, asked his readers to put probabilities on possible outcomes and gave his own assessment:
Core PCE, by the way, is the personal consumption expenditure price index excluding food and energy, which the Federal Reserve prefers to use to guide monetary policy and is somewhat different from the Consumer Price Index. We won’t have that number for February until later this month, but as of January the index was up at a 2.5 percent annual rate over the previous six months, while unemployment in 2023 never went above 4 percent. So we were comfortably in Furman’s upper left box — the scenario he thought had only a 10 percent chance of happening.
And we’re very, very far from the predictions of some other economists, most famously Larry Summers, who believed that we’d have to go through years of very high unemployment to get inflation down.
That said, recent data — including this morning’s — has been somewhat disappointing, with two somewhat hot consumer price reports in a row and faint hints of a deteriorating labor market. Has the soft landing been called off?
Probably not. I’m trying not to engage in motivated reasoning here, but I believe that there are good reasons not to take those hot inflation numbers too seriously. I’m actually a bit more worried about rising risks of recession.
First things first: You may have read that consumer prices excluding food and energy rose 3.8 percent over the past year. That sounds pretty bad. But I don’t know any serious economists who believe that this is an accurate picture of underlying inflation.
For there are two big problems with that number. First, a year is too long: Inflation was falling over the course of 2023, so year-over-year numbers are giving us a picture of the past. Second, that rise in core C.P.I. is largely driven by rising shelter prices, mostly owners’ equivalent rent — a price that, by definition, nobody actually pays — and for technical reasons official measures of shelter prices lag far behind market rents, which at the national level have been close to flat for a long time.
So where are we really? I like to look at the six-month change in consumer prices excluding food, energy, used cars and shelter — not because the excluded items don’t matter, but because they’re either highly volatile or, in the case of shelter, a badly lagging indicator. That index is rising at a 2.8 percent annual rate.
We can parse the numbers further, and many economists are busy doing that as I write. But let me give you some other indicators that give me some confidence that underlying inflation is well under 3 percent.
One indicator is wages. Average hourly earnings have risen at an annual rate of less than 4 percent over the past six months, while productivity (a volatile number, especially during and immediately after the pandemic recession) has risen at an annual rate of 1.6 percent since the eve of the pandemic. That suggests an underlying inflation rate around 2.5 percent.
I’m also looking at private business surveys, which show no hint of the inflation pop in the official data. Here, for example, is what purchasing managers surveyed by S & P Global said about input prices (the percentage saying prices are up is generally closely correlated with the inflation rate — the chart shows the percentage of businesses reporting an increase in prices, so a level higher than 50 means they’re rising on average):
There’s no hint there, or in any of the other surveys I’ve seen, that inflation is reaccelerating. So I’m pretty sure that the inflation side of the soft landing story is still intact.
I’m a bit more worried about the unemployment side. February’s unemployment rate of 3.9 percent was still low by historical standards, but the rate has crept up a bit. Many people, myself included, keep a close eye on the Sahm rule — an empirical regularity, discovered by Claudia Sahm, a former Fed economist, that focuses on three-month averages of the unemployment rate. (As it happens, one of the sad but funny things you see a lot of in economics-related social media is guys — almost always guys — mansplaining the Sahm rule to … Claudia Sahm.)
The rule says that a recession is highly likely if that three-month average rises more than half a percentage point above a previous low. It’s been so useful in the past that FRED, the invaluable economics data source, provides ready-made charts of the Sahm rule measure:
As you can see, this measure has been creeping up. It’s still below that critical 0.5 level, but I am worried that high interest rates may finally be taking their toll and that by keeping rates high, the Fed is running the risk of finally making all those wrong recession calls come true.
But for the moment, at least, we’re still very much in soft landing territory. Eventually something will go wrong, because something always does. But compared with the dire predictions of many economists, not to mention political critics of the Biden administration, we’re still in incredibly good shape.