The Fed is working on something it has never done before: sharply lower inflation without significantly raising unemployment.

Never in the past 80 years has the Fed needed to reduce inflation by 4 percentage points (the core PCE price index is close to 6 per cent) while ensuring that it does not cause a recession.

The labour market will be the key to a safe landing. Unemployment usually rises sharply during a recession. At present, the unemployment rate in the United States is 3.6%, which is unusually low, and the demand for workers is so strong that companies have listed millions of job vacancies.

Fed officials say they can curb this demand, allowing employers to eliminate job vacancies without layoffs and curb inflation without a recession-what economists call a "soft landing".

But even one of the Fed's closest partners, Treasury Secretary Yellen, sees the risk of failure. The former Fed chairman said publicly in Washington last week:"it takes skill and luck. "

Federal Reserve Chairman Powell said last month:"No one thinks that a soft landing will be plain sailing in the current situation-almost nothing is plain sailing in the current situation. "He also said the Fed faces a "challenging task."

Four landings in American history

According to the Wall Street Journal, in seven different periods over the past 80 years, US inflation has fallen by as much as the Fed now wants, but with different results.

It focuses on four of the landings.

In the early 1980s, the United States experienced what economists call a classic hard landing.The United States fell into a deep recession with double-digit unemployment after the Federal Reserve raised its benchmark interest rate to nearly 20 percent to curb inflation, which has been stubbornly high for more than a decade.

In the 1950s, the recession that the United States experienced was less severe, but the economic landing was not smooth, mainly characterized by a brief surge in inflation and recession. During this period, even if economic output shrinks, unemployment rarely reaches a very high level.

In the 1970s, beset by external shocks, such as the OPEC oil embargo and the Fed's reluctance to raise interest rates sharply, inflation first fell and then suddenly rose, leading to a failed landing.

There are also soft landings, most recently in 1994.In February 1995, then Federal Reserve Chairman Alan Greenspan sharply raised interest rates to 6% from 3% a year earlier, while the unemployment rate continued to fall.

However, unlike in 1994, the Fed today is trying to reduce already excessive inflation, while what Greenspan did was to stop inflation from rising before high inflation emerged.

The Wall Street Journal commented thatThese examples show that, while the risk of failure is high, the ideal scenario is theoretically possible, not least because the Fed is chasing existing inflation, rather than tackling the problem before it arises, as in previous periods.

The newspaper quoted Jon Turek, founder of policy research firm JST Advisors, as saying:

My framework for thinking about the Fed now is that 1994 is the target, but they no longer need to be overly afraid of what happened in 1980, or at least not as scared as I thought.

The hope of the Federal Reserve

With the risk of a hard landing high, the Fed's success will depend on several factors beyond its control.

These include whether global energy supplies can recover from the crisis in Russia and Ukraine, thereby lowering energy prices; whether marginalized American workers can rejoin the labor force, thereby alleviating labor shortages and wage increases; and whether the global epidemic can subside, thereby ending economic disruptions and supply chain bottlenecks.

If these supply constraints are eased, the Fed's job will be easier.

Among them, the situation of the job market is more important.

In February, US companies announced 11.3 million job openings, an increase of 4 million from before the outbreak and an all-time high.

Part of the reason for this gap is the shortage of labour. The labor force participation rate in the United States was 62.4% in March, still one percentage point below its pre-epidemic level, which means fewer workers are looking for work.

This mismatch is also driven by strong demand from employers. Tad Peelen, co-owner of a restaurant group in Gilbert, Arizona, said:

"We all thought that there were fewer employees available for us to choose from, but the number of employees preparing to work in restaurants was the same or larger than it was before the outbreak. Now I am beginning to understand that the reason why it is so difficult for us to recruit is that there are too many restaurants open. "

Goldman Sachs Group analyst estimatesThe Fed can achieve its goal of reducing inflation and wage pressures by reducing about 2.5 million job openings.Goldman Sachs Group estimates that if the labour force participation rate returns to pre-outbreak levels, it will add about 1 million workers, which will make it slightly easier for the Fed to ease the imbalance between supply and demand in the labour market.

Fed officials have begun to pay attention to this in recent weeks.

It will be more difficult to achieve a "soft landing" if supply constraints persist.

However, if these supply restrictions persist, the Fed will need to raise interest rates to squeeze demand, which could do more damage to the economy.

According to the Fed interest rate bitmap, officials expect the benchmark interest rate to rise to about 2.75% by the end of next year, slightly higher than expected that will neither stimulate nor slow economic growth.

At the same time, they expect inflation to fall to just over 2 per cent by 2024, a rare drop of 4 percentage points in less than three years; economic output will grow at a rate of 2 to 3 per cent, while unemployment will remain below 4 per cent.

Ellen Meade, a senior policy adviser who retired from the Federal Reserve last August, said:

In my opinion, this is unlikely to happen, and the likelihood of doing so without a hard landing has declined.

John Taylor, an economist at Stanford University and founder of the Taylor Rule, an influential rule of thumb for policymaking, says his formula requires the Fed to now set interest rates at 5 per cent. Since the Fed is unlikely to raise interest rates sharply within a year, he said officials should raise interest rates to 3 per cent by December and signal further increases after that unless inflation falls.

Taylor says:

This is not the only time in history that they have fallen behind, but they have obviously fallen behind, and they need to catch up and do so in a systematic and understandable way.

Will this landing be similar to that of the 1950s?

Robert Hall, a professor at Stanford University, has found that unemployment has followed a predictable pattern for decades, both during and after recessions-rising sharply during recessions and falling slowly and steadily during expansion, a pattern that lasted from the 1960s to 2020.

The epidemic disrupted these patterns, and the slow decline was replaced by an astonishingly rapid decline.

He says the unemployment rate he sees today looks more like the 1950s, when the unemployment rate was less volatile because of the Fed's efforts to stabilize inflation, but "everything was more volatile as a whole".

Another similarity is that, as at the time, the US is going through a cycle of fiscal policy wobbles.

From 2020 to 2021, federal spending as a share of US GDP rose from 21 per cent to 31 per cent, and the White House Office of Administration and Budget (OMB) expects it to return to 24 per cent by 2022 and less than 23 per cent by 2023.

This is the biggest fluctuation in federal spending since World War II. During World War II, the Fed also kept interest rates low to support the economy and war spending after the Great Depression.

Brainard, the future number two of the Fed, said reducing fiscal stimulus would also help dampen demand.

For now, Fed officials agree that they should seek to quickly raise interest rates to levels that no longer provide stimulus. They have hinted that they may approve a 50 basis point increase in interest rates at next month's meeting and possibly again in June. The Fed has not raised interest rates so much since 2000.