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  • Writer's pictureKerwin Donis

Soft Landing: What It Means & Is It Likely?

Headlines and journalists have been debating whether or not a soft landing is possible for our economy in the face of The Fed’s ongoing battle against inflation, and they’re use of interest rates as their weapon against it.

The term “soft landing” has been thrown around, but what does that even mean? And what are the implications if The Fed succeeds - or fails -to achieve a soft landing?

We’re diving into all of that and more below.

What Is A Soft Landing?

A soft landing is considered a “cyclical slowdown in economic growth that avoids recession.” A central bank will aim for a “soft landing” when they are looking to raise interest rates enough to cool off an economy, usually in response to high inflation. But, the key is that they want to prevent plunging the nation into economic distress, which can occur as a result of hiking interest rates. The imagery of a plane is useful here. Passengers would far more prefer a soft landing that is gradual rather than a hard one, which can be painful.

Soft landings are by no means a guarantee when it comes to The Federal Reserve and past periods of interest rate increases.

A Walk Down Soft Landing Lane

Alan Greenspan, the former Federal Reserve chair, popularized the use of “soft landing” to describe the Fed’s goal of avoiding an economic downturn. It’s believed that he successfully achieved a soft landing between 1994-1995. According to Jerome Powell, the Fed had similar results in 1965 and 1984. But these are exceptions, not the rule.

Between 1970 and 2008, there were five periods where inflation reached over 5%. In each of these periods, there were at least two back-to-back quarters of negative GDP growth, meaning the economy went into a recession.

The Fed’s response to inflation was (and currently is) hiking interest rates. But The Fed isn’t some miracle-working body of superheroes. Their track record isn’t exactly perfect when it comes to their ability to hit the “soft landing” target. But this isn’t exactly their fault.

Keep In Mind…

Driving the economy is not like driving a plane. With a plane, the pilot has much more control over the vehicle than The Fed has over the economy. Sure, they have various tools at their disposal, which we’ll dive into in a bit. But still, their ability to influence the economic forces aren’t always enough.

These tools include “interest rates and asset holdings,” both of which can’t account for complex issues relating to supply chain bottlenecks, pandemics, or union strikes.

The members of the Fed have parroted this notion in the past. “"If making monetary policy is like driving a car, then the car is one that has an unreliable speedometer, a foggy windshield, and a tendency to respond unpredictably and with a delay to the accelerator or the brake,” said Ben Bernanke, the former Fed chair, in December of 2008.

Soft vs Hard Landings

For context, the main role of a central bank is to ensure economic and financial stability through monetary policy. In a rising inflation environment, The Fed - America’s central bank - will push interest rates higher in an attempt to push consumer spending down. But this is a delicate dance. If interest rates increase too high or too fast, this can trigger a “hard landing.” A “soft landing” involves a small increase in interest rates at a slow rate.

The Making Of A Formidable Enemy Named Inflation

There are five primary catalysts for a rise in inflation.

The first occurs when demand for goods and services in an economy exceeds the supply of those goods and services. Since there are more people who want the same amount of goods and services, the prices of them rise.

When the cost of the raw materials and labor required to produce goods and services increases, this can also force the prices of these goods and services to rise as a consequence.

Other factors that contribute to higher inflation include an expansion of the money supply (as seen by COVID stimulus checks), an increase in wages in an economy, and when a country’s currency is devalued.

The Arsenal To Fight Inflation

The Fed has three main “weapons” against inflation, all of which allow it to enact monetary policy. They can control bank reserve requirements, the discount rate, and the open market.

Bank Reserve Requirements: This is exactly what it sounds like. The more money a bank has to have in reserves, the less they can lend out, and vice versa. This has an impact on the amount of money floating around in the economy.

The Discount Rate: This is the rate banks are charged to borrow money from the central bank.

Open Market: This involves the purchase and sale of securities.

Clear For Landing

By now, it’s clear why achieving a soft landing is easier said than done. The economy takes time to react to monetary policy, and there are many confounding variables that contribute to the current state of the economy besides The Fed’s actions. But this doesn’t understate the impact rising interest rates have on the real estate market and the economy at large.

It’s important for real estate investors to understand what a soft landing aims to accomplish, and what the consequences are when it’s missed.

And now that you’ve reached the end of this article, you’re hopefully closer to reaching this understanding.

Let’s hope that we’ll see a soft landing firsthand in the coming months- and avoid the alternative.

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