A hard reality may lurk below Fed `soft landing'



WASHINGTON -- In the cool and quiet marble corridors of the Federal Reserve, the strategy for taming inflation sounds painless, even soothing: a "soft landing" for the economy after several years of flying high.

As the central bank contended Tuesday, when it decided to pause its two-year effort to raise interest rates, inflation is "elevated" right now but will begin to decline because economic growth is poised for a modest slowdown.

Many economists, however, warn that a "soft landing" may seem anything but, and suggest that the Federal Reserve is either too rosy about the looming slowdown or naive about the difficulty of reaching its goal for inflation.

The Fed has actually orchestrated only one "soft landing":during 1994 and 1995, when its chairman, Alan Greenspan, was able to slow the economy enough to cool spending and ease inflationary pressures but not enough to cause a big increase in unemployment. But even Greenspan, whose ability to fine-tune policy made him a legend, presided over two recessions, in 1991 and in 2001.

This time, many analysts say the Fed and its new chairman, Ben S. Bernanke, face considerably tougher challenges. Oil, at more than $70 a barrel, is at prices that would have been unthinkable in 1995.

Productivity growth, which was accelerating in 1995, is slowing today. The dollar, which was climbing against other major currencies in 1995, is declining against most of them today.

Analysts say that if Bernanke is serious about his goals for controlling inflation, at least 2 million additional workers might have to lose their jobs over the next two years.

"The economic slowdown has to be much more substantial than anybody in the Federal Reserve or on Wall Street is expecting," said Robert J. Gordon, a professor of economics at Northwestern University who has analyzed the trade-off between inflation and unemployment for the past several decades.

Bernanke and other Fed officials have often said they want to keep "core" inflation - excluding energy and food prices - below 2 percent a year. But core inflation is already 2.9 percent and almost certain to climb as oil pushes up prices for everything from airfares to plastics.

Gordon said the past few decades have shown a grim but consistent trade-off: to reduce inflation by 1 percentage point, the unemployment rate has to rise about 2 percentage points for an entire year.

So to reduce inflation to the upper limits of what Bernanke and other Fed officials consider acceptable, more than 3 million jobs would be lost, a bigger decline than the one caused by the recession of 2001.

And that is Gordon's rosy scenario, which assumes no other shocks to the economy - no additional increases in energy prices, no collapse in the dollar, no collapse in the housing market.

"I think the Fed is facing an absolutely classic case of stagflation," Gordon said, "a situation in which they cannot win."

He is not alone. Many economists contend that inflation is more entrenched and will be more painful to reverse than the Fed is predicting. Others predict that inflation will indeed subside, but only because the economy will weaken much more than the Fed is expecting.

The chief forecaster at Decision Economics, Allen Sinai, said unemployment would have to climb to at least 5.5 percent from 4.8 percent now - meaning an additional 1 million people are of work - before inflation begins to decline.

The chairman of Roubini Global Economics Monitor, Nouriel Roubini, predicted that the economy would fall into a recession in early 2007 as a result of high energy prices, higher interest rates and a collapse in the housing market.

"Either the Fed does not believe its own inflation forecast, which I don't think is the case, or the slowdown is going to be greater than what they have been saying," Roubini said. "They can't have it both ways."

To be sure, economists differ on how weak the economy already is or how severe inflationary pressures are. And skepticism abounds about the chances of achieving a true "soft landing."

But Laurence H. Meyer, a former Fed governor and now a chief forecaster at Macroeconomic Advisers, said Bernanke needs to do more than simply replicate Greenspan's one successful "soft landing."

Greenspan was not trying to reduce inflation, but merely keep it from going up. Bernanke, by contrast, is trying to reduce it substantially.

"Soft landings are much more frequent in forecasts than in real life," Meyer said. "With a computer, I can give you a soft landing if you give me 10 or 20 runs. But in real life you only have one run."

Uncertainties and disagreement among experts about the economy's direction are unusually high. One big uncertainty is whether the nation is near full employment.

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