US economy heading towards a ‘hard landing’

Subject :Economy

Section: Monetary Policy

In News: US economy likely to experience a hard landing in view of inflation and unemployment numbers.

Key Points:

The recent inflation and employment data point to two things:
- First, inflation continues to remain elevated vis-à-vis the US central bank’s goal of keeping the annual PCE price index increase to 2%.
- Second, falling unemployment, is putting upward pressure on wages and, in turn, driving up inflation.

Why is a hard landing likely?

Given the inflation scenario, the Federal Reserve has no choice but to raise interest rates further. As credit becomes more expensive, businesses and consumers will hire and spend less.
Economic activity slowing would then reduce overall demand, help cool overheated labour markets, and eventually bring inflation under control.
Fed has already substantially hiked its funds rate from a target range of 0-0.25% till March 16, 2022 to 4.5-4.75% in the last Federal Open Market Committee meeting on January.
Hiking further would risk what economists term a “hard landing”. When inflation is persistent at 5% and the target is 2%, interest rates will have to be increased high and fast enough, and kept at those levels until economic activity moderates sufficiently.
It is the opposite of subdued growth or a mild recession (“soft landing”), which follows the Fed having to raise rates only slowly and in small amounts to reduce inflation from, say, 3% and cool an economy not that overheated.

Difference between hard and soft landing

A hard landing in economics signifies a rapid and severe economic downturn, often triggered by factors like financial crises, bursting asset bubbles, or abrupt policy changes.
This scenario results in a sharp decline in economic growth, possibly leading to a recession.
Hard landings typically have significant adverse effects, including rising unemployment, business investment declines, and financial stress for individuals and companies.
Recovery from a hard landing can be challenging and prolonged, necessitating aggressive policy responses like interest rate cuts and fiscal stimulus.

In contrast, a soft landing is an economic scenario characterized by a gradual and controlled slowdown in economic growth:

This transition aims to move from a period of rapid expansion to a more sustainable and stable growth rate.
Policymakers proactively implement measures to moderate economic growth and prevent overheating, often involving less disruptive policy actions.
Soft landings are preferred as they seek to maintain economic stability, avoiding severe disruptions, and are typically associated with a more balanced and sustainable economic environment.