History as a guide

Question: Why can't the Fed get inflation down to 2% without a recession?

Donald Ellenberger: Jerome Powell, chairman of the Federal Reserve Bank, has said that there is a path to bring inflation back down to the Fed's 2% target without raising rates so high that the Fed inadvertently causes a recession. Now, we hope he's right, but we're skeptical. In the past, whenever inflation has been above 4% and the unemployment rate has been below 4%, the Fed has never been able to pull off a soft landing for the economy. Not once. We suspect this time may not be any different. It was pretty easy to get inflation down from 9% to 4%, but to get inflation from 4% down to 2% might not be possible without a recession, and here's why. The Fed's long term central tendency for the unemployment rate is 4%. So that means the Fed thinks a 4% unemployment rate is the tightest the labor market can be without wage pressure keeping inflation above the Fed's 2% inflation target. The unemployment rate today is about half a percent lower than the long-term level consistent with stable inflation. So to get the labor market to soften to the point that it's no longer exerting upward pressure on inflation, the Fed believes the unemployment rate has to rise about a half a percent. But here's the critical point. In the past, every single time the unemployment rate has risen half a percent from the lows, we have always been in the early months of a recession. So if history is an accurate guide, getting inflation down to 2% means getting the unemployment rate to rise in amount that has always in the past meant the economy was sliding into a recession, every single time. So we think it's very unlikely the Fed can get inflation back down to 2% without at least a mild recession.