What Is a Soft Landing in Economics?

A "soft landing" in economics refers to the scenario where an economy moderates its growth and inflation without entering a recession. This delicate balance is challenging to achieve, especially in the aftermath of significant economic shocks like the COVID-19 pandemic. In recent times, central banks have been working towards a soft landing by adjusting interest rates to stabilize the economy and control inflation.

The Current Economic Landscape

As of 2024, the US economy has been distinguished by achieving growth rates of 2.5–3%, while its developed market (DM) peers have largely stagnated at 0–1%. The U.S. economy's outperformance is attributed to factors such as a larger cumulative fiscal stimulus since 2021 and the slower pass-through of higher interest rates to households, largely due to the existing stock market of low-rate, long-term mortgages. However, as these factors fade, the U.S. economy is expected to recouple with the global economy.

Central Banks' Role

Central banks, particularly the Federal Reserve, have been actively managing interest rates to support a soft landing. In September 2024, the Fed reduced its benchmark interest rate by 50 basis points to a range between 4.75% and 5%, aiming to protect full employment and preserve the soft landing achieved following the pandemic-induced price shock. The Fed projects additional 25 basis-point reductions at its November and December meetings, with the policy rate expected to end this year at 4.4% and 3.4% by the end of next year. This rate-cutting cycle is part of a broader strategy to normalize interest rates, ensuring that the economy continues on the path towards a soft landing.

Challenges and Uncertainties

Despite the efforts to achieve a soft landing, there are several challenges and uncertainties. High budget deficits in the U.S. are likely to persist, limiting the potential for further fiscal stimulus and adding to economic risks. Additionally, stubbornly high inflation rates and rising joblessness pose significant concerns for the Federal Reserve. While the September consumer price index showed some stickiness in inflation, with core inflation rising to 3.3%, this is not seen as a reacceleration risk by some economists. The Fed's dual mandate of achieving price stability and full employment remains a guiding principle as it navigates these complexities.

Corporate Fundamentals and Market Growth

The success of a soft landing also hinges on corporate fundamentals. Morgan Stanley's Global Investment Committee emphasizes that economic stability and market growth increasingly depend on companies' ability to meet earnings expectations, which are already ambitious. Earnings growth is estimated to be about 13–14% through the end of 2025, driven by expanding margins and productivity gains rather than cost-cutting efforts. This extraordinary margin expansion is tied to investments in infrastructure, clean energy, semiconductor competitiveness, and supply-chain realignment, as well as the integration of generative AI into business operations.

Historical Perspectives

Delivering a soft landing is a historical challenge for central banks. A recent ECB Blog post highlighted that only about one-third of monetary policy cycles end in soft landings, where inflation returns to target within two years without triggering a recession. Successful soft landings are often characterized by a growth slowdown followed by a strong economic recovery and declining inflation over the subsequent two years. Central banks must balance slowing down the economy just enough to bring inflation back down without going too far and triggering a recession.

Conclusion

Achieving a soft landing in economics is a delicate and challenging task. The recent actions by the Federal Reserve, coupled with a focus on corporate fundamentals and historical perspectives, underscore the complexities and uncertainties involved in navigating this economic scenario.