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3 reasons the US might actually fix inflation without a recession

Is it time to celebrate the economy’s “soft landing” yet?

A plane coming in for landing.
A “soft landing” from last year’s inflation crisis appears increasingly plausible.
Getty Images
Dylan Scott covers health care for Vox. He has reported on health policy for more than 10 years, writing for Governing magazine, Talking Points Memo and STAT before joining Vox in 2017.

The US economy is looking good. A “soft landing” — getting last year’s skyrocketing inflation under control without a recession — appears increasingly plausible. All of its structural inequities largely persist, of course, but wages are strong, unemployment is low, and the economy is still growing. The Federal Reserve is no longer projecting the US will enter a recession in the near term.

It’s worth remembering just how unlikely this all seemed a year ago. As the Federal Reserve started to hike interest rates to try to fight inflation, many commentators regarded some kind of a recession as a fait accompli. After all, if you look at the history, an inflation crisis has usually required an economic downturn, which means a lot of people losing their jobs and feeling financial pain, in order to get prices under control.

It’s too early to declare victory. Inflation is still not as low as the Fed would like. But the US economy is outperforming most of its peers in both productive growth and slowing inflation.

So how did we get here? I endeavored to find out and find a way to tell the story of the past 18 months for those of us who might not intuitively know that an inverting of the yield curve can predict a recession until we read a Vox explainer on the subject. (TL;DR: When yields on short-term Treasury bonds are higher than those of long-term bonds, this is an inversion of the typical pattern and implies investors are anticipating a recession.)

To be clear, the landing could still get bumpy. US-China trade tensions could flare up. We may not have heard the last of weaknesses in the banking sector exposed by Silicon Valley Bank’s collapse. Another unexpected disaster, geopolitical or natural, can never be ruled out. And the gridlock in Washington could make it more difficult to respond if such a thing occurs.

But, the bottom line is, according to Dana Peterson, chief economist at the Conference Board, who recently briefed President Joe Biden on the economy: “The likelihood of recession has lessened, and the likelihood of soft landing has increased.”

No single explanation will suffice and economists still disagree about what exactly is driving the gears of the economy. But I spoke with a handful of leading experts. Here are three theories that, taken together, explain how the US might pull this off.

1) Pandemic-related economic disruptions have dissipated

The shock that the Covid-19 pandemic sent through the economy in the spring of 2020 was unprecedented. But even as economic activity picked back up in the months to come, it was not the pre-pandemic economy. Spending habits changed.

Instead of buying a gym membership, people bought a Peloton for their home. Some people moved to a new house in a new neighborhood and, rather than ride on public transportation as they had, they purchased cars, maybe a used car, to adjust to their new post-pandemic life.

But at the same time, people were buying more of those goods — more Pelotons, more furniture, more home-based tech, more cars — the supply chains for those products were being disrupted by the pandemic. Production stopped or slowed as factories shut down. Trade dropped considerably and prices rose in response given the high demand, the first step toward an inflation crisis. Housing prices were soaring as people decided to move; at the same time, new construction was hobbled by supply constraints.

“It’s almost like wartime change in the composition of demand,” Josh Bivens, chief economist of the left-leaning Economic Policy Institute, told me. “We tried to shove a bunch of that demand into sectors whose global supply chains were collapsing because of Covid.”

Meanwhile, the service side of the economy largely collapsed and 22 million people lost their jobs in a very short time.

There was something unusual about this period of historically high unemployment: Many workers still had a lot of cash, thanks to the pandemic relief bills passed by Congress. Even as the economy started reopening and businesses tried to rapidly hire back many of the people they had laid off, workers could be choosy. Research has found that people who have more savings tend to take longer to find work. It makes intuitive sense too.

And if somebody lost their job for whatever reason, there were plenty of other positions available. That combination of low unemployment and plentiful job openings is unusual, and it propped up workers but also helped create the inflation crisis. People who have more money tend to spend more money and, given Covid’s constraints on supply, that is also going to increase prices.

This apparent overheating was at its peak last summer when, at the same time, the Russian invasion of Ukraine had led to energy prices skyrocketing. The US was looking at 9 percent inflation, and the Fed, which up to that point had regarded inflation as transitory, decided it needed to act.

But Bivens and other experts I spoke to said that they believed these effects were always going to be transitory. As the economy got further away from the disruptions of the past few years, inflation would slow naturally, without intervention.

The slowdown in housing prices in particular, and their secondary effects, take a long time to show up in inflation data. Consumer spending was also bound to cool off. Peterson said she has been surprised by the persistence of consumers’ “revenge spending” — people spending on travel and other entertainment after a few years in which that was practically impossible. One theory for why: Goods people pay for on a credit card are not as exposed to rate hikes as a loan on a car or a major purchase — but she also said that spending would inevitably ease as people start to run out of their excess savings from the pandemic.

One major financial firm’s forecasting team said they attributed about 40 percent of price increases last year to these transitory factors. That still left an inflation problem, but a more modest one than the headline numbers would have suggested.

2) The labor market has been gradually normalizing

Supply chain problems were not something the Fed was equipped to deal with, and those factors have largely been normalizing on their own. The roaring labor market, however, was a more obvious target for the Fed’s fiscal policy once inflation became unpalatable.

Here is why many experts saw a soft landing as difficult to pull off: The Federal Reserve had made clear it was going to raise rates, because inflation had reached untenable levels and something had to be done, and it’s hard to control the effects of those rate increases. The expectation is that they will lead to a slowdown in business and consumer spending, which leads to layoffs, which leads to less spending. That’s how you end up in a recession.

But the labor market has proven stubbornly resistant: More than 200,000 jobs were added in June, and unemployment stayed stuck at 3.6 percent despite a year of rate hikes.

Part of the explanation is that certain sectors — such as health care, business services, and entertainment — are still rehiring from their losses during the pandemic. Companies have also been holding on to workers. Peterson told me her company’s recent surveys of CEOs have found executives were expecting a recession, but they expected it to be mild, so they were less interested in preemptively making cuts.

The abundance of job openings also prevented a jump in unemployment, even as interest rates started to rise. Usually, when somebody loses a job, they have to cut back on their spending, which then has more knock-on effects: Less consumer spending leads to more layoffs leads to less spending. That’s why the unemployment rate tends to rise sharply in a short period, if you look back at historical trends.

But lately, it’s been so easy for people to find work that we haven’t set off the vicious chain reaction that can lead to a recession. Instead, companies have been cutting back on their job openings over the past year (from 11,400 in May 2022 to 9,800 in May 2023) more gradually. The labor market has been settling down, rather than all crashing down.

And with job openings gradually decreasing, wage growth has also been cooling. The fear was that low employment would keep driving wages higher, which would keep pushing prices up. That potentially toxic combination of prices and wages rising together led to the Fed’s initial decision to increase interest rates.

But after peaking last spring, nominal wage growth has steadily come down, from 5.8 percent in April 2022 to 4.4 percent in June 2023. Historically healthy, but more in line with the pre-pandemic trend lines.

A graph from the Economic Policy Institutes shows the change in private-sector nominal average earnings over the last 20 years. It peaks in 2020 and again in the spring of 2022, before settling at 4.4 percent this year. Economic Policy Institute

This was the goal, the controlled — or “soft” — landing out of last year’s inflation crisis that the Fed was aiming for but many people didn’t think it could pull off. The fear was that the economy couldn’t move in this gradual way, that once the Fed kicked things off with a rate hike, the labor market would spin downward until we hit a recession.

But instead, propped up by some of the unusual features of the post-pandemic, a soft landing is in sight. One other factor deserves credit, odd enough: the American consumer.

3) People didn’t freak out

The economy is really humanity as a macroorganism. All of our individual habits and our expectations feed off one another, creating reality as much as experiencing it. That is why, once people started to expect a recession amid the inflation crisis, there was a fear that it could become a self-fulfilling prophecy no matter the Fed’s aim for a soft landing. People and businesses who are expecting a recession tend to spend less, which leads to layoffs, which leads to less spending.

Likewise, expectations of inflation can lead to more inflation. Businesses preemptively increase prices, and a similar spiral gets underway.

But, despite an initial false alarm that contributed to the Fed’s decision to intervene last summer, Americans’ expectations about long-term inflation were always pretty low. People expected inflation to be high in the short term, but not in the long term, according to the University of Michigan’s consumer survey. Even short-term expectations have normalized in the past few months, after running hot for most of last year.

Why did we keep our heads? Some experts see it as a long-term win for fiscal policy. After the stagflation crisis of the 1970s and 80s, the prime directive for central banks has been to keep inflation in check. Consumers, therefore, have come to expect low inflation. So even though inflation took off in the wake of the pandemic, it may have been easier for people to accept it would be temporary, because they’ve become accustomed to low inflation as the default state of the economy.

And because consumers and businesses weren’t panicking, the Federal Reserve didn’t have to either. One forecaster at a major financial firm described the effect this way: Early on, financial leaders were saying that inflation likely wouldn’t get down to target levels until 2025 because they thought it would be exceedingly difficult to wrangle the beast. A lot of economic pain, engineered by the Fed itself, would be necessary in the meantime.

But over time, the premise behind a 2025 timeline has shifted. With inflation cooling off while the economy still looks healthy, the Fed can afford to take the more gradual approach. Everybody is keeping calm and carrying on.

“If the economy is doing really well, inflation is going in the right direction, let that ride,” Bivens said. “Don’t mess with it.”

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