Can Greenspan Engineer Soft Landing?

Jan. 10, 2001 -- Everyone hopes that Federal Reserve Chairman Alan Greenspan can successfully steer the economy to a desired and elusive “soft landing.” But what, exactly, constitutes “soft?” And will we, in fact, land that way, or get a recession instead?

To start with, an actual recession is defined as two consecutive quarters of negative growth in gross domestic product (a measure of all goods and services produced).

On the other hand, a soft landing is generally viewed as a slowdown in GDP growth from 4 percent to 5 percent to just above zero, explains Kevin A. Hassett, an economist and resident scholar at the AmericanEnterprise Institute.

Added Hassett: “If you don’t slow down enough to gointo a recession, it’s a soft landing.”

By way of context, the Commerce Department, which measures GDP, recently revised down its measure of third-quarter gross domestic product from an estimated 2.4 percent pace of growth to 2.2 percent. That’s down sharply from the blistering 5.6 percent pace set in the second quarter, and is the slowest growth in four years. But it’s far from a recession.

Greenspan Taps the Brakes

With the economy in high gear for several years running and high growth threatening to push up prices for goods and services, the Fed raised interest rates six times between June 1999 to May 2000 to keep the economy from overheating.

Then, perhaps persuaded that the brakes had been applied too forcefully, the Fed on Jan. 3 cut a key interest rate by a half-point, saying that a recession, not inflation, posed the bigger economic risk.

That last move follows a wave of economic signals, including weak corporate earnings and deteriorating consumer confidence, suggesting the slowdown was occurring with unexpected speed.

Win Some, Lose Some

The Fed’s aim is to slow the economy enough to stimulate a modestincrease in unemployment, says Mark Zandi, chief economist atEconomy.com, a Web-based provider of economic research.

But hitting the nail right on the head is no easy operation. Greenspan pulled it off in 1994, raising interest rates a number of times to cool an overheatedeconomy and stock market. And again late that year, GDP was growing at an annual rate of 5 percent before higher interest rates slowed the pace to 0.8 percent by the second quarter of 1995, achieving a soft landing.

A similar scenario was seen in 1990 and 1991, but growth dipped down intonegative territory and the nation went into recession, albeit ashort and shallow one.

So can the Fed pull it off this time?

“I think there’s less than a 50 percentchance of a recession,” says Robert Klemkosky of Indiana University. Klemkosky sees dangers in what he calls the “reverse wealtheffect” — the evaporation of wealth [on paper at least] resulting from plummeting stock prices.

“When stocks stumble people entrench themselves and cut down on consumption,” he says. “This will cause an economic slowdown of a greater magnitude than we originally thought.”

Bump in Road is Nothing to Fear

But differing is Hassett: “I think there’s abetter than 50 percent chance that we’ll go to negative growth in the last quarterof this year or the first two of next year.” Hassett, like Klemkosky, was interviewed before the Fed unexpectedly cut rates last week to try to avert a hard landing.

“We will have a hard landing,” Hassett added, “butwe shouldn’t get carried away with how hard it is. As longas the government doesn’t make dramatic changes to economic policy, theeconomy has a good record of handling these sorts of occurrences. It will not shake the fundamentals of firms. Profits will be lost, but wewill not be seeing any really big problems. While the risk is high thatthis will fall apart, I think this time we’ll make it.”