HARD LANDING – SOFT LANDING – SLOW LANDING
First published Wednesday 02/22/2023
The development of an accurate, unbiased, totally inclusive analysis of all the factors that have combined to create the present global and domestic economic morass, and which will track the ongoing path of economic drive growth (either positive or negative) would be a daunting task. Needless to say, the gurus and pundits from the various political viewpoints, who claim to have great insight regarding economic matters, have pontificated, and have come to conflicting conclusions. These mathematical wizards, who tend to put their thumbs on the analytical scale by choosing the underlying assumptions and macro factors that support their agenda driven goals, sacrifice accuracy and honesty for political expediency. Econometricians who construct macroeconomic models that project economic growth are, in effect, utilizing sophisticated statistical tools to project difficult to measure sociological activity and economic wellbeing over time (lots of errors). Most macroeconomic modelers fall into the Keynesian camp and are subject to a demand side policy bias that skews the sensitivity of dominant parameters to imbedded demand side assumptions (more errors).
Instead of attempting to analyze total domestic economic growth which depends on generating an unending list of long-term capital related factors in addition to ongoing short run agenda driven policies (including Federal Reserve activities), and exogenous events (such as the Ukraine War) that collectively drive the economy, I have analyzed the individual effects of specific policies and events that have impacted the economy either positively or negatively. In a number of papers, I reviewed different fiscal policy blunders and myopic non-optimal green policy excesses that have damaged the domestic economy while not improving the environment. I would be remiss if I did not emphasize the massively inflationary impact of the political left’s war on fossil fuels. In other papers I have discussed the problems related to actions of the Federal Reserve when it is slow to address inflation (despite the obvious warning signs) and later if it acts too aggressive once it finally realizes that inflation is not a transitory event.
At this point in time, the various economic gurus are “all over the map” regarding the aggressive tightening policy of the Federal Reserve, the stickiness of prices (slow level of disinflation as interest rates are increased) and the surprisingly continued appearance of labor market strength. The Fed’s apparent adherence to “Phillips Curve” analysis (which postulates a stable inverse relationship between unemployment and inflation) is being tested by the present situation where overall unemployment is not increasing as the Federal Reserve aggressively increases the benchmark interest rate, the economy is showing signs of contraction and inflation is slowly moderating. Even though this situation may appear to be confusing to a hard-core Keynesian, it is not surprising to me, nor should it be to anyone that understands the benefits of supply side policies with an eye on global markets.
Looking first at the apparent lack of response of the labor market to interest rate hikes by the Fed, it is widely recognized that there will always be a lag between an interest rate increase by the Fed and overall market reaction. What has been causing a bit of “head scratching” by hard core Keynesians is that there has been virtually no overall response in the labor market to the tightening actions of the Fed which were initiated almost a year ago. Some contraction in parts of the labor market is occurring, but overall employment has not decreased and in many sectors labor is still quite tight. Blind acceptance of the “Phillips Curve” has been under scrutiny for some time and the present situation is a prime example of why that is the case. The Fed has indicated at this point in time (Q1 2023), it has no intention of reversing its interest rate policy this year unless inflation drops significantly – which has not happened yet. Remember that the Federal Reserve was “late to the party” in recognizing the threat of severe inflation and is quite capable of being too slow to reverse its policy.
The lingering strength of the economy should not be a surprise to an unbiased economist. Until the passage of the Inflation Reduction Act late in 2022 (which in part, imposed a 15% minimum tax on large corporations) the across-the-board tax cuts implemented by the 2017 Tax Cut and Jobs Act have been in place. In addition to across-the-board tax cuts, this act incentivized the repatriation of an immense amount of corporate funds trapped offshore by the onerous tax structure that prevented repatriation. This adjustment in the tax code resulted in at least one trillion dollars returning on shore.
Supply side economists have accurately noted that the above referenced 2017 tax cuts had a significant positive impact on economic growth that led to record real wages for middle- and lower-income individuals while maintaining extremely low inflation. Given the immense strength of the economy leading into the Pandemic in 2020 and the rapid recovery coming out of the shutdown starting in Q4 of 2020, the maintenance of a free market friendly tax structure into 2021 guaranteed robust economic growth. As I have always maintained, the shutdown of the economy in 2020 was poorly planned and in so many ways counterproductive, but the strong economy leading into the pandemic and much of the 2020 emergency stimulus led to a swift recovery. At that point in time, supply and demand was sufficiently in balance such that growth was robust, and inflation was extremely low.
The federally mandated pandemic shutdown and the excessive transfer payments undertaken in 2020 were maintained for the most part in 2021. Widespread global shutdowns, combined with massive agenda driven government spending in 2021 and 2022 on both the domestic and global levels, created a lot of chaos in critical global supply chains as well as the domestic labor market, with the labor force participation rate dropping due to the excessive handouts without any work-related restrictions. This created a situation where fewer workers were chasing available jobs. The Federal Reserve stumbled when it declared inflation to be transitory in 2021, and the country endured unprecedented inflation in 2022, which has continued to be problematic in 2023. The reality is that all of the spending and transfer payments upended the demand/supply balance in the economy by artificially increasing demand for goods and services, thereby radically overheating an already strong economy. Consequently, when the Fed finally woke up in 2022 it then had to cool down a “red hot” economy while facing the headwinds of fiscally irresponsible spending by the Biden Administration. Even though the money supply has been dropping since the Fed started to increase the federal funds rate, the money supply is still too high. This acts in opposition to the Federal Reserve’s efforts to dampen demand.
Surprise, surprise – Inflation has remained stubbornly high going into 2023, with the economy appearing to be resisting the efforts of the Federal Reserve to cool it down. Companies are reporting better quarterly revenue and profit figures than anticipated – but note that these figures are amplified by inflation and the ability of companies to pass on cost increases to the consumer. Given that the growth friendly tax code was still in place during 2022 coupled with the massive demand side stimulus caused by inflationary Federal Government spending, the economy has had a strong tailwind going into 2023 making it tough for the Federal Reserve to tame inflation. The first and second quarter Gross Domestic Product (GDP) readings will be extremely revealing regarding the disinflationary demand controlling efforts of the Federal Reserve. This will be seen in contrast to the quarterly reports of publicly traded corporations. GDP is reported in real dollars (net of inflation). As the lagged effects of the Federal Reserve’s target rate increases accumulate, borrowing for consumption and capital investment becomes more expensive, the money supply continues to decrease, credit card debt starts to become problematic (now at an all-time high – Q1 2023), and labor markets finally begin to weaken, to the surprise of the pundits, one or more negative quarters of GDP may quickly arise.
Many of the pundits are calling for a soft landing and some are calling for a hard landing, but keep in mind that both are premised on the inflation rate returning to the Federal Reserve’s 2% target rate. The soft-landing scenario is the case where the target inflation rate is achieved with a very shallow or no recession followed by a quick recovery. The hard landing scenario is the situation in which the target inflation rate is reached, but as a consequence of the Federal Reserve’s actions, the economy is driven into a deep recession, which will have a significant negative long-term impact on economic growth. It appears as though the probability of a slow or even no landing is becoming increasingly likely. In other words, by the end of Q2 (2023) if the demand side of the economy does not drop sufficiently such that it is clear that the demand/supply imbalance in the economy will return to relative balance in a timely manner, inflation can be expected to remain stubbornly above the target rate into 2024, forcing the Federal Reserve to maintain a restrictive posture for an extended period of time. This slow landing scenario portends a return to the Obama period’s new normal of little to no growth over an extended period of time. Welcome to the economic reality of the socialist state, where the government takes over enough of the spending and investment decisions that should be made by the free market, such that the “golden goose” can no longer spin its economic growth magic, the engine that has given us the quality of life we take for granted.