Mark Thoma ponders a hard landing

This time a hard landing of stagflation. A few days ago, he pondered a hard landing caused by a dollar crisis.

So many things to go wrong. In a dollar crisis, interest rates would spike, and that would be a contributing factor in slowing the economy. In stagflation, inflation takes off at the same time unemployment rises and the Fed must decide if it will raise or lower real interest rates (nominal rates will be rising due to inflation). Could a dollar crisis touch off a bout of stagflation? Yes, it could.

Mark plans to write more about hard landings in the coming days. That's good. It's worthy of discussion. I'll throw in my 2 cents from time-to-time.

I don't think I've defined what I think of as a hard/soft landing yet, so here goes.

I am a licensed (but currently inactive) pilot. I have been at the controls of a single engine airplane for many landings, some hard and some soft. Let me tell you, it's every pilot's goal to make the perfect "soft" landing--the one where you don't even feel the wheels touchdown. It's rare, and it takes a lot of skill just to have a chance at a soft landing.

When a new pilot makes a hard landing, it's usually because he or she thought the runway was about a foot higher than it really was. The pilot did a nice job of essentially landing the plane in the air a dozen inches off the surface. The airplane, not knowing any better, figured that its job was done and stopped flying... and began a brief one foot free-fall. Coffee gets spilled, but no lives are lost. Do it a few more feet up an you might bend the landing gear. Do it a hundred feet up and you might not live to tell about it.

Another kind of hard landing is coming in too fast and slamming into the ground. Use your imagination. New pilots do this once in a while too. As long as you correct for it before you hit the runway, you might save the upholstery, but probably not your pride as the folks in the hangar watch you float half a mile down the runway.

Last but not least is the hard landing that just happens. Everything is perfect and then the wind changes. It's like someone suddenly dropped you towards the ground. Been there. It stinks.

What's my point? I remember when the term soft landing started to be used to describe what the Fed did in 1994-95. I liked the term because it seemed to describe in familiar aviation style terms what was happening. The changes in interest rates in 1994-95 were like the corrections that a pilot makes when coming in to land. Too much too soon and you land above the runway and free-fall (choking off the expansion). Too little too late and you either slam into the ground or float half a mile (runaway inflation). Of course, you could do everything right and still spill your coffee when the wind changes at the last minute (oil price spikes).

When things change at the last minute, things can indeed get dicey for both pilots and central bankers. You don't want to use all of your ability to control the situation until you really are safe on the ground. That is Mark's point, and it is a correct one--for pilots and central bankers.

Greenspan did a lot of things right in 94-95, and got lucky besides. The wind didn't shift suddenly on us then, unless you count the Peso crisis, which did make things touch-and-go for a while (aviation pun intended) but was ultimately not much of a factor (for the U.S.) in the soft landing that followed. We had plenty of policy ammunition left to deal with it.

A soft landing is stable inflation and unemployment at sustainable levels in the maturing phase of an expansion. You'll know it when you feel it (or don't feel it, as the case may be).

This story will continue for a while. I imagine Mark and I will be commenting periodically on this until we... uh, land.