In August 1982, I arrived in Washington to begin a year’s work on the White House Council of Economic Experts. Yes, it was the Reagan administration, and I was already a centre-left. But it was more of a technocratic than a political position, and the new board president, Martin Feldstein — a moderate Republican, a species that has since all but disappeared — wanted some data geeks. I was supposed to focus on international issues, and Larry Summers became the new domestic economic policy officer. What happened to him?

Anyway, Marty and I had a work dinner on the night of my arrival, and there he asked me an important question: “Is the global economy about to collapse?” There were two main reasons for his concern. One was that Mexico had just announced its inability to continue paying its debts, signaling the start of a debt crisis in Latin America. Another reason was that the Federal Reserve’s efforts to fight inflation sent the American economy into a tailspin, and the American people experienced the worst recession since the 1930s, unmatched by any before the 2008 financial crisis.

But, as it turned out, the world economy did not collapse. The debt crisis has become a “lost decade” for Latin America, with widespread severely negative economic consequences, but has not developed into a global economic “pandemic”. And in the US, the US Federal Reserve’s 180-degree turn has finally triggered a quick recovery. By 1984, Ronald Reagan was bragging about America’s economic “sunshine”.

But then again, the memory of this summer makes me somewhat uneasy about the economic optimism that seems to be everywhere right now, at least in the media. Predictions of a “soft landing” – when inflation falls to an acceptable level without triggering a recession – are being played more and more often. And my forecast is indeed for a soft landing: inflation seems to be easing, and while we may not be able to completely avoid a recession, if it does, it will most likely be moderate.

However, the experience of the early 1980s continues to be of concern for two reasons.

Two reasons for concern

First, controlling inflation in the 1980s was extremely painful.

Inflation fell from about 10% to 4%. But the deflationary process brought with it a huge, long-term boom in unemployment. The financial results, officially presented at the time, provided for a very high percentage of casualties. In late 1984, when Reagan was talking about how good the economy was, the unemployment rate was more than double what it is today.

According to some, we may have to go through such a phase again. At least a few months ago, Summers published deflationary scenarios similar to those of the 1980s, stating that unemployment would have to rise to almost 6% to control inflation.

I think he is wrong. The distortions caused by the pandemic have made estimating hidden inflation much more difficult, to the point where we are no longer sure what the term means, but many of the measures announced in an attempt to clear up the confusion show a decline in inflation despite no rise in unemployment so far.

Inflation is already largely contained – and, it is worth repeating, without much rise in unemployment. So, like I said, I think Larry is being too pessimistic. But am I sure? Of course not.

Another reason why the experience of the 1980s is so important to me is that by 1982 it became clear that the Fed had slowed down more abruptly than it intended. This means that he was trying to slow down the economy – essentially by deliberately causing a recession – but he did not want to cause such a severe recession. It is a fact that then, as now, politicians tried to manage the economy using limited, often outdated information and using largely inaccurate tools.

In particular, the Fed is trying to reduce inflation by slowing down the economy, that is, by raising interest rates. But there is a clear dichotomy about how much the economy needs to slow down, how much interest rates need to rise to reach a certain rate of slowdown, and how long to fully implement rate hikes. Sometimes I think the Fed looks like a man trying to start cars in a dark room with kitchen gloves on.

So even if we don’t need a sharp recession to bring inflation under control, it could end if the Fed brakes too hard. There is, of course, the opposite risk: the Fed does too little and inflation runs rampant. But I think the latest inflation data is positive enough to justify risking and easing rate hikes, at least for the time being.

What is the conclusion? A soft landing has become much more likely than it seemed just a few months ago. But this is by no means a done deal.

According to the New York Times.