MNI: Fed Sees ‘Growth Recession’ As Best Case—Ex-Officials

The Federal Reserve has started to acknowledge that an economic soft landing may be hard to pull off, hoping instead for a “growth recession” where the pace of expansion slows down significantly with only a modest rise in the jobless rate, former central bank officials told MNI.

Fed Chair Jerome Powell appeared to curb his own optimism on the recovery in his latest press conference as he referenced a “softish” landing that doesn’t “materially” boost unemployment.

“A growth recession is what they’re shooting for,” said William Dudley, ex-president of the New York Fed. “The problem is that they have never been able to pull that off when they’ve had to push up the unemployment rate more than marginally.”

While recent labor market strength has underpinned the Fed’s view that it can raise interest rates fairly aggressively without knocking the economy into the recession increasingly feared by investors, officials’ optimism has nonetheless dimmed from only a few weeks ago, when Powell spoke of how soft landings were more frequent than generally believed. (See: MNI: Fed’s Barkin–Tamping Inflation Will Take Time)

“It might require a bit of a growth recession, that is a bit of an increase in the unemployment rate with growth continuing, no real recession, but much softer to relieve some of this pressure on the labor market,” Dohn Kohn, former Fed vice chair, told MNI. “It could well take a bit of a low trend growth and higher unemployment rate to dampen demand.”

A growth recession, generally defined as a period of expansion so slow that it leads to a loss of jobs rather than gains, would ease price pressures associated with an unemployment rate currently at a historic low of 3.6%. Fed officials point to other measures of labor market tightness potentially contributing to high inflation, which has quickly become the central bank’s top priority as consumer prices shot more than 8% higher on a yearly basis.

Powell and his colleagues are placing great emphasis on the job-to-vacancy ratio, which is at a record high of 1.9. They seem to believe they can pull some of the slack out of the labor market by denting vacancies without a large increase in the ranks of jobless workers.

60s GROOVE

Jeffrey Lacker, former president of the Richmond Fed said policymakers may be shooting for a scenario like that which transpired in the mid-1960s.

“When the Fed raised rates, they got a slowdown, they backed off and there was a growth pause – growth slowed but not enough to make it a technical recession,” Lacker said in an interview. “That is about the best scenario I think they can hope for because they’re not going to slow inflation much, given the momentum it has now, without materially affecting demand.”

In the event that things don’t go as planned and the best-case scenario does not materialize, ex-officials said policymakers would cross their fingers for a mild recession.

Powell hinted at this prospect when he said the Fed should be able to bring down inflation without “a severe downturn.”

“The broader question of ‘is the Fed willing to engineer a recession to get inflation under control’? I think that they are,” said Luke Tilley, a former Philadelphia Fed policy advisor now at Wilmington Trust.

“It’s because of those long-term inflation expectations that they need to get under control. A technical recession that would slow the economy down – that would be a possibility that the Fed would be willing to have that happen.”