Article28 Sep 2023

Recession vs. Soft Landing

What lessons does the past hold that might inform views for the next 12 months and whether we’re heading for a US recession, or an economic soft landing?

Moderating wage and price inflation, an unemployment rate that remains surprisingly low and an economic trajectory that feels broadly in line with a soft landing. Can the current state of play in the U.S. continue?

A recent Citi Research report look at five episodes of wage disinflation since 1965 in search of clues.

Global Chief Economist Nathan Sheets and team continue to think that a period of rising unemployment, with a corresponding economic downturn, will be needed to loosen up a tight U.S. labor market and associated wage and services inflation. But they admit that the economy’s resilience and increasing signs of disinflation make that a tough call.

To help make that call, the team looks at the recent evolution of U.S. wage data, considering how much further wage growth will need to fall to bring inflation into line with the Fed’s expectations. And what would such an adjustment likely mean for the unemployment rate? In tackling these questions, Sheets and his team look at five episodes of significant U.S. wage disinflation since 1965.

Their findings: All five episodes were associated with periods of recession. To get meaningful traction bringing down wages, a broader slowing of the economy has been needed, with a marked rise in the unemployment rate. To be more specific, in these episodes two percentage points of wage deceleration looks to be associated with a two to three percentage-point rise in unemployment.

Those findings lead the authors to conclude that despite encouraging signs in recent data, “there are few antecedents in the U.S. experience for anything approximating a soft landing.” If there is to be a soft landing, the case has to be made for why this time will be different.

Looking at wage data

As a first step, Sheets and team ask: What pace of wage growth is likely to make Fed Chair Powell and his colleagues comfortable? The Fed is looking for wages to rise at a pace consistent with its inflation target, which suggests to the authors underlying wage growth of roughly 3% to 3.5%—the sum of the 2% inflation target plus their estimate of trend labor productivity growth, which looks to be around 1% to 1.5%. The intuition, they write, is that rising productivity increases firms’ margins and allows them to pay higher wages without additional price hikes, essentially financing higher wages with higher productivity.

To evaluate wage performance, the authors looked at two principal measures of wage growth: average hourly earnings (AHE) and the employment cost index (ECI). The two generally move together, and both indicate wages are now up roughly 4% to 4.5% from a year ago. Moreover, both of those series indicate wage growth has moderated: The 12-month change in AHE peaked at 5.9% in March 2022, while ECI peaked at 5.1% in 2022’s second quarter.

Labor Productivity Growth


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