US Federal Reserve welcomes “soft landing”, even if many Americans are not in the mood to celebrate

When Jerome Powell delivered a widely watched speech last month, it was the closest the Federal Reserve Chairman has come to saying that the inflationary surge that has gripped the nation for three painful years has now essentially been defeated.

And not only that. The Fed’s high interest rates have made it possible to achieve this goal without triggering a widely predicted recession and high unemployment, Powell said.

Still, most Americans are not in the same celebratory mood about the decline in inflation, given the high interest rates imposed by the Fed. Although consumer sentiment is slowly improving, some polls show a majority of Americans still complaining about increased prices, with the cost of essential goods such as food, gasoline and housing still far above the levels they were before the pandemic struck in 2020.

The relatively poor mood among the population poses challenges for Vice President Kamala Harris, who is seeking to succeed President Joe Biden. Despite the decline in inflation and strong job growth, many voters say they are dissatisfied with the economic record of the Biden-Harris administration – and particularly frustrated by high prices.

This discrepancy points to a glaring gap between how economists and policymakers assess the economic situation in recent years and how many ordinary Americans assess it.

In remarks at an annual economic symposium in Jackson Hole, Wyoming, last month, Powell stressed that the Fed’s sharp rate hikes had managed to control inflation far better than most economists predicted without damaging the economy – a notoriously difficult task known as a “soft landing.”

“Some argued that a recession and a prolonged period of high unemployment were necessary to bring inflation under control,” Powell said.

Ultimately, however, he noted, “the 4.5 percentage point decline in inflation from its peak two years ago occurred in an environment of low unemployment – a welcome and historically unusual result.”

With high inflation now largely overcome, Powell and other central bank officials are preparing to cut interest rates for the first time in more than four years in mid-September. The Fed is increasingly focusing on supporting the labor market with lower interest rates rather than continuing to fight inflation.

Many Americans have suffered a severe blow

Many consumers, however, are still primarily concerned with the current price level.

“From an economist’s and central banker’s perspective, it has been a really remarkable achievement in terms of inflation that inflation has risen, recovered and is now close to target,” says Kristin Forbes, an economist at MIT and former employee of the UK’s central bank, the Bank of England.

“But from a household perspective, it has not been so successful,” she added. “Many have had to accept large wage cuts. Many of them feel that the basket of goods they buy is now much more expensive.”

Two years ago, economists feared that the Fed’s continued rate hikes – which ultimately raised its benchmark interest rate by more than 5 percentage points to a 23-year high, at the fastest pace in four decades – would hit the economy hard and cost millions of jobs. After all, that’s exactly what happened when the Fed under President Paul Volcker raised its benchmark interest rate to nearly 20 percent in the early 1980s, ending a brutal period of inflation.

In fact, two years ago in Jackson Hole, Powell himself warned that using high interest rates to curb rising inflation “would be painful for households and businesses.”

But now inflation is at 2.5%, according to the Fed’s preferred measure, not far above its 2% target. And while weaker hiring is causing some concern, the unemployment rate is still low at 4.3% and the economy grew at a solid 3% annual rate last quarter.

While no Fed official will outright declare victory, some find satisfaction in defying the doom prophecies.

“2023 was a historic year for a decline in inflation,” said Austan Goolsbee, president of the Chicago Fed. “And there was no recession, and that is unprecedented. And so we will be studying the mechanisms of how that happened for a long time to come.”

However, consumer sentiment suggests that three years of painful inflation have clouded the outlook for many Americans. And high loan rates and rising home prices have raised fears among many young workers that home ownership is becoming increasingly out of reach.

“Inflation overhang”

Last month, consulting firm McKinsey said in its latest survey that 53 percent of consumers “still cite rising prices and inflation among their concerns.” McKinsey analysts attributed the increased number to “an inflation overhang,” the analysts’ belief that it may take months, if not years, for consumers to emotionally adjust to much higher price levels, even if their salaries keep pace.

Economists cite several reasons for the wide gap in perception between economists and policy makers on the one hand and consumers and workers on the other.

First, the Fed bases its interest rate policy on inflation—the rate of price change—rather than on the price level itself. So when inflation rises sharply, the central bank’s goal is to bring it back to a sustainable level, currently 2%, not to reverse price increases. Fed policymakers expect average wages to catch up and eventually allow consumers to afford the higher prices.

“Central bankers think that even if inflation deviates from 2% for a period of time, it’s OK as long as it goes back up,” Forbes said. “Victory, mission accomplished. But the period of time that inflation deviates from 2% can come at a high cost.”

Research by Harvard economist Stefanie Stantcheva and two colleagues has shown that most people’s views on inflation are very different from those of economists. Economists generally view inflation as a consequence of strong growth. They often describe inflation as the result of an “overheated” economy: low unemployment, strong employment growth and rising wages cause companies to raise their prices sharply without necessarily losing sales.

In contrast, a survey by Stantcheva found, ordinary Americans view inflation “as something unequivocally bad and very rarely as a sign of a good economy or a byproduct of positive developments.”

Respondents to their survey also said they believed inflation was caused by excessive government spending or greedy corporations. They “do not believe that (central bank) policymakers need to make trade-offs, such as reducing economic activity or increasing unemployment, to keep inflation under control.”

Perceived recession

For this reason, few consumers were likely worried about a potential economic downturn as a result of the Fed’s rate hikes. In fact, one poll found that many consumers mistakenly believed the economy was in recession because inflation was so high.

Andrew Bailey, Governor of the Bank of England, argued at the Jackson Hole conference that central banks could not guarantee that high inflation would never occur – they would only try to reduce it again if it did occur.

“I get asked that question quite a lot in Parliament,” Bailey said. “People say, ‘You’ve failed to get inflation under control.’ I say no.”

The test of a central bank, he continued, “is not that we will never have inflation. The test of the regime is how well it brings inflation back to target once it is hit by such shocks.”

Still, Forbes said there are lessons to be learned from the post-COVID inflation spike, including whether inflation in both the U.S. and the U.K. remained too high for too long. The Fed has long been criticized for taking too long to start raising its benchmark interest rate. Inflation first spiked in the spring of 2021. But the Fed, wrongly assuming that high inflation would prove to be “transitory,” did not begin raising rates until nearly a year later.

“Maybe we should think again about where we are now: ‘As long as it comes back in four to five years, it’s OK,'” she said. “Maybe four to five years is too long.”

“How much unemployment or slowdown in growth should we be willing to accept in order to shorten the period during which inflation is too high?”