The term “hard landing” in monetary policy refers to attempts to lower inflation, often through tighter monetary policy like raising interest rates, that lead to a major economic slowdown or recession. In contrast, a “soft landing” occurs when inflation is controlled without significantly harming economic growth.
In This Post
The Role of Monetary Policy in Hard Landing
Aggressive Rate Hikes: Central banks, such as the Federal Reserve, raise interest rates quickly to combat inflation. Higher rates make borrowing costlier, reducing consumer spending and business investment.
Credit Tightening: Increased interest rates often lead to stricter lending requirements. This limits access to credit for individuals and businesses, further slowing economic growth.
Demand Destruction: Business and consumer spending declines, reducing overall demand in the economy. While this can lower inflation, it risks layoffs, business closures, and slower GDP growth.
Delayed Effects: Monetary policy impacts the economy with a time lag. By the time its effects are fully felt, the economy may have slowed more than expected.
Historically, several examples illustrate hard landing:
- In the 1980s, under Chairman Paul Volcker, the Federal Reserve raised interest rates significantly to curb soaring inflation. Although inflation fell, the U.S. experienced a severe recession in the early 1980s.
- In other instances, the Fed raised rates aggressively, slowing the economy or pushing it into recession.
- In 2007, the Fed tightened monetary policy to cool the real estate market. This triggered a hard landing, leading to the Great Recession. The speculative bubble had grown too large for a soft landing to be feasible.
Why Does It Occur
A hard landing may result from central banks misjudging the economy’s sensitivity to interest rate changes. It can also happen if inflation proves more persistent than expected, requiring prolonged tightening. External shocks, such as geopolitical events or financial crises, can worsen the situation.
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