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April 21, 2005
Landings, Hard and Soft: Part 2
Continuing with my thoughts on the Delong wrap-up post: William Polley does not shrink from defining "hard landing" -- more specifically "soft landing" -- in his contribution:
A soft landing is stable inflation and unemployment at sustainable levels in the maturing phase of an expansion. You'll know it when you feel it (or don't feel it, as the case may be)...
For my money this is a pretty strong definition of soft landing, and it seems to me that William implicitly does as well:
I remember when the term soft landing started to be used to describe what the Fed did in 1994-95. I liked the term because it seemed to describe in familiar aviation style terms what was happening. The changes in interest rates in 1994-95 were like the corrections that a pilot makes when coming in to land
Fair enough, but I don't think that the 94-95 episode is a great description of a bump-free landing. Real GDP growth slowed substantially, from 4.4 percent in 1994, to 2.4 percent in 1995. For the first half of 1995, annualized GDP growth was less than 1 percent. The unemployment rate actually increased throughout the year before ending 1995 at the same level it stood at the end of 1994.
Things worked out pretty well in the end, of course, but if that period is a good example of a soft landing -- which seems reasonable to me -- the scenario comes with a pretty good soft patch.
April 21, 2005 in The "Landing" Strip | Permalink
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Comments
Posted by:
CalculatedRisk |
April 21, 2005 at 11:57 AM
I keep coming back to the 94-95 period as my idea of a soft landing too. Funny thing is I am getting there by thinking about the peso crisis. It began with rising U.S. interest rates in Spring 94 which produced gradual spread widening and ended with emerging market debt trading at default values.
It was of course a soft landing though because economic growth (and market prices) recovered as soon as the Mexican loan package was put in place. The real economies in emerging markets never caught up to the disaster that the markets priced in.
I am pretty sure this series of events and the policy response played a large role in the outcome within the U.S. as well.
Posted by:
michael |
April 21, 2005 at 12:57 PM
Well, there are degrees of softness, that's for sure. The first half of '95 did come in under 1%, but the second half came in around 3%. And don't forget that right before that (November '94) was a 75 basis point hike in the funds rate. In the transcripts of that meeting it was mentioned that the market had priced in at least 50 basis points and they wanted to go beyond that. That would be expected to cause the soft patch, which it did. The importance of staying ahead of the curve cannot be understated. FOMC policy in the latter part of the '94-'95 cycle was anything but "measured."
My reading of the situation is that in '94-'95, the FOMC had not yet created the expectations in the market conducive to a softer landing than what we got. Transparency helps. All my griping about "measured pace" aside, I think we are in a position to commit to a path that will engender stable prices, perhaps an even better position than '94-'95. That is from a monetary policy point of view, of course. The fiscal picture is another issue, and make no mistake, it does complicate things (as commentary on Greenspan's remarks today will surely make clear).
Can you even imagine what sort of a bump in our landing a 75 basis point hike would create in the present environment? It's not even an appropriate comparison, of course. 50 b.p. would be enough to send a chill given current expectations. All that makes 1995 look even more amazing to me.
Posted by:
William Polley |
April 21, 2005 at 04:30 PM
To stay with the aeroplane metaphor, I met an ex-aircrew, who told me how he washed- out of Pilot training. He found that if he cut his engine when he passed over a farmhouse he made a perfect landing. On his final flight,his first solo flight, the wind had shifted, in the new circumstances, he hadn't a clue and had a very hard landing. Let's hope a previous solution works, for the Economy.
Posted by:
Eric Bloodaxe |
April 21, 2005 at 08:57 PM
Dr. DeLong has added to his thoughts on a hard landing:
http://www.j-bradford-delong.net/movable_type/pdf/hard_landing.pdf