Modern economics makes itself intelligible by adopting everyday analogies. If inflation worsens, we say the economy is “overheating.” If the Federal Reserve raises interest rates, it’s “applying the brakes.” If it cuts rates, it’s “stepping on the gas.” The metaphor of the moment is “soft landing.” The economy slows enough to avoid higher inflation but not so much that it suffers a “hard landing” (a recession). It’s an enticing vision–which may or may not come true.
The trouble with these analogies is that, even as they clarify, they oversimplify. The case for a “soft landing,” though plausible, may not come true because the economy is not an airplane and Alan Greenspan–chairman of the Federal Reserve Board–is not its pilot.
The main difference involves control. Pilots have a lot of it. Landings and takeoffs are routine. By contrast, the Federal Reserve tries to steer the nearly $10 trillion U.S. economy through one tiny instrument: the obscure Fed funds rate. This is the interest rate on overnight loans between banks. When the Fed funds rate moves, the ripple effects spread to other short-term rates (on home-equity loans, business loans), long-term rates (on mortgages, bonds), exchange rates, the stock market and popular psychology. But the connections aren’t always the same or entirely predictable.
To shift analogies: the Fed has a small lever (the Fed funds rate) to move an immense boulder (the economy).
Confidence in the “soft landing” stems from the current boom–which has consistently defied pessimists–and a fervent faith in Greenspan.
He prides himself on acting preemptively: judging economic conditions and altering rates to prevent major problems. After Asia’s financial crisis in 1997 and 1998, the Fed cut rates. Beginning in June 1999, it started raising them again on the theory that the boom–if unrestrained–would create inflationary wage and price pressures. Sure enough, these seemed to appear in early 2000. Through May the consumer price index has risen at an annual rate of 3.6 percent compared with a 2.7 percent rise for all of 1999.
But right on schedule, it seems, the slowdown arrived:
Retail sales–everything from food to cars–dropped in April (0.6 percent) and May (0.3 percent).
In May the unemployment rate inched up to 4.1 percent from 3.9 percent, and private-sector jobs declined by 116,000.
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Housing construction has weakened, with new-home starts in May–at an annual rate–10 percent lower than in December.
“Consumers have been on such a spending binge that while they say it’s a good time to buy a car or house, they’ve already bought a car or house,” says economist Cynthia Latta of Standard & Poor’s DRI.
The economy seems to be landing softly. But could this picture be wrong? Well, yes.
For starters, the slowdown might be a mirage–a “temporary payback” for the rapid growth of late 1999 and early 2000, says economist Ira Kaminow of the Capital Insights Group. In the last three months of 1999 the economy grew at an astounding annual rate of 7.3 percent. People may have bought in December what they would have bought in May. Once this effect wears off, the economy may resume growing at more than 4 percent–faster than the Fed wants–and require further interest-rate increases.
Or the slowdown might prove worse than expected. “Lower-income household debt is very high,” says Mark Zandi of Regional Financial Associates. “That may be the economy’s Achilles heel.” Even in 1998, about a fifth of households with incomes of less than $50,000 needed 40 percent or more of their after-tax income to pay interest and principal on debt, he reports. Higher gasoline prices are another possible problem. They could depress consumer confidence and spending, says Susan Sterne of Economic Analysis Associates. Jobs, profits, the stock market and corporate investment could suffer. (But none of these economists yet predicts a recession.)
Everyone is dealing in educated hunches. The imagery of a “soft landing” promotes a false sense of mastery. Pilots know how far and fast their planes can fly. With radar, they have a good sense of weather and terrain. Our economic vision is more clouded. Statistics and studies give incomplete or conflicting answers about the economy.
The larger point is that the economy responds to its own rhythms: new technologies, products, popular moods, management practices, government policies. In the 1960s and 1970s, the metaphor of choice was “fine tuning.” Government could sustain “full employment” by tweaking various policy dials–taxes, spending, interest rates. The effort failed notably. This history is worth recalling, because it suggests that today’s hyperconfidence could usefully be accompanied by some humility.