Soft or hard landing?

Kevin Hassett is an economist who served as the 29th Chairman of the US President’s Council of Economic Advisors.

In the past, Federal Reserve Chair Jerome Powell has spoken about a soft landing where unemployment goes up slightly, but a severe recession is avoided. Looking ahead, what are the prospects for a soft landing?

I think the most likely outcome right now is that there is a harder landing next year. And I think that there are a couple of reasons for that. The first is that it's been something of a puzzle to the macro economists that the hikes that we've seen so far did not cause a recession or cause an extreme slowing.

You could ask yourself, well, why is it that the tightening didn't slow GDP? And the answer is that we gave people so much money in COVID stimulus cheques that they were able to keep buying goods and consuming a lot, even though inflation was making the goods more costly.

If you look at savings in the US, then you can see that the COVID savings or the excess COVID savings are pretty much gone. And so therefore, the thing that was making it so that folks could continue to buy consumption goods is no longer available to them. And so I expect that consumption is going to start to go down.

Similarly, because of the geopolitical risks in the Middle East and Ukraine, people are going to get more risk averse, investors are going to get more risk averse. And as we go into an election cycle next year, capital spending will probably slow down, too, as firms wait to see which party wins and what it means for economic policy.

So I think that there are a number of forces that are saying the next year we're going to have a hard landing. But I expect that even when we do have a hard landing, that inflation will still be high.

Looking at 2024, an election year in the US, what would you your prediction be for Federal Reserve policy going forward?

The history of Fed policy in presidential election years is that they tend to look ahead and recognize that they could become a political issue if they raise interest rates in the months before an election. And so they tend to avoid doing that. And so what it means is that if the Fed thinks that there's a chance that they might want to raise rates because of inflation, say, in September, then they might do it even with weaker evidence, say in June, because they know they want to get the hikes out of the way before the election comes.

Looking beyond the U.S., what are you most worried by what you're seeing?

I think that Europe is in a very tricky place right now because the fiscal situation in some southern European countries, especially Italy, is very problematic. Perhaps not as problematic as in the US. But since you have one currency for all the countries, it makes the kind of tightening that is necessary given that inflation is out of control in Europe as well a trickier business because there are some countries that might even have risk of default if interest rates go higher. And so I’m most worried about Italy but I’m just as worried that the ECB will be slow to fight the continued inflation because of worry about the impact of tightening on the more troubled countries.