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Federal Reserve Chairman Jerome Powell has spent the past two years fighting inflation at the risk of triggering a recession. He is now on the verge of winning that battle without bringing down the economy, but the next few months will be crucial.

The Wall Street Journal analysis pointed out that if Powell succeeds in achieving a soft landing for the economy, his name will be recorded in the history of the central bank's hall of fame. If he fails, and the US economy falls into recession under the pressure of rising interest rates, then the old saying circulating on Wall Street will be verified:“Economic expansions don’t die; they get killed by the Fed.”

Powell speaks during a news conference in July.

With upward price pressures easing but the job market cooling, Powell and his colleagues have signaled in recent weeks that they will start cutting interest rates in September, putting the spotlight on how quickly the Fed can bring rates down from a 20-year high.

rightThe final stretch of the Fed’s battle against inflation is a decisive moment for Powell, who delivered a widely anticipated speech during the annual gathering of global central banks, highlighting the Fed’s impending rate cuts.

At the annual meeting two years ago, when people were doubting the Fed's determination to fight inflation, Powell made a solemn promise. He cited the example of former Fed Chairman Paul Volcker, suggesting that he was willing to accept a recession as the price of curbing high inflation. As we all know, in the early 1980s, the Fed pushed interest rates to very high levels, which led to a painful downturn in the economy, but high inflation was eventually curbed.

The Fed under Powell also rapidly raised interest rates in 2022 and 2023. However, Powell insisted that the Fed can avoid triggering a recession because inflation in 2021-23 is different from what happened in the 1970s.

Striving for a soft landing would be the ultimate redemption for Fed officials who three years ago wrongly predicted that inflation was a blip. A successful soft landing would show that the Fed’s failure to put the brakes on its aggressive stimulus in 2021 was not disastrous.

"This will be their moment of glory, when Fed officials can say 'not only did we prevent runaway inflation of the kind we saw in the 1970s, we did it without causing material damage to the economy,'" said Dario Perkins, an economist at GlobalData TS Lombard.

Powell has a chance to emulate two of his heroes. If the soft landing works, Powell can be said to combine the toughness of Volcker with the flexibility of Alan Greenspan, who as Fed chairman in the late 1990s resisted calls to cool the economy as the boom produced little inflation.

In 1980, then-Federal Reserve Chairman Paul Volcker spoke to a crowd protesting high interest rates in Washington.

'A bad omen'

As Powell struggles to navigate a divisive election campaign, the Fed's decisions could affect the state of the economy when the next president takes over. Democrats including Massachusetts Sen. Elizabeth Warren have criticized Powell for not cutting rates sooner and have made no secret of blaming him for the economic downturn.

Trump, who appointed Powell as Fed chair in 2018, has said he wants a bigger say over interest rate policy if he wins the White House again this fall. The prospect of a recession has emboldened the Republican candidate to shape the Fed to his liking.

Powell remains concerned about the state of the economy, with the mild-mannered Fed chairman saying the “possibility of hitting the runway or sliding off the runway keeps him up at night.” Powell, 71, avoids the term “soft landing,” referring to it instead as a “good outcome” or “something we all want,” according to people who have worked with or spoken to him.

Richmond Fed President Thomas Barkin expressed similar concerns in an interview last week: "I try not to use that term. It's a bad omen."

The economic situation is no longer what it used to be

Concerns about the labor market have raised questions about the pace of rate cuts. Inflation has fallen to around 2.5% from more than 7% two years ago, not far from the Fed's 2% target. But the unemployment rate rose to 4.3% in July from 3.7% at the beginning of the year, a historic low. Whenever the unemployment rate starts to rise, it will rise sharply afterwards.

However, some Fed officials worry that rate cuts could trigger new price pressures and undermine their hard-earned gains.

The U.S. economy has repeatedly defied forecasts of an imminent recession, remaining strong despite high interest rates over the past two years. Now there is evidence that the unique buffers that have protected the economy so far are eroding.

Budgets of low- and middle-income consumers are beginning to come under pressure, and more companies say they are once again focusing on cutting costs to attract deal-conscious shoppers.

The U.S. housing industry has avoided the slump that usually follows a sharp rise in interest rates, but the outlook is grim. Potential homebuyers today have less income and wealth than they did two years ago when mortgage rates first surged above 6%.

In the labor market, companies have slowed hiring. For now, layoffs are low. The decline in labor demand was initially restrained, but it may soon exceed a critical point. The Labor Department said on Wednesday that job growth in the 12 months ending in March was likely revised down to 2.1 million from the nearly 3 million initially reported, implying more modest job growth through most of 2023 and the first three months of this year.

“If job openings fall more, then the unemployed won’t be able to find new jobs as easily,” said Peter Berezin, chief global strategist at BCA Research.

Stick to a soft landing

Many recessions will initially look like soft landings, but the U.S. has had one only once since World War II, in 1995. Back then, Fed Chairman Alan Greenspan tried to preempt inflationary pressures by rapidly raising interest rates from 3% to 6%. He then reversed course and cut rates to 5.25% within six months.

Whether Powell can accomplish that task depends not only on whether the economy weakens faster beneath the surface but also on whether rate cuts can spur new borrowing and spending to offset any weakness. Investors are optimistic because the Fed has plenty of room to cut rates. But even with lower borrowing costs, some borrowers may still face pressure from the lagged effects of past Fed rate hikes.

A soft landing appears to be within reach, with the economy so far tracking closer to the optimistic scenario described by Federal Reserve officials two years ago.

Alan Greenspan, then chairman of the President's Council of Economic Advisers, listens to representatives of the then-troubled housing and construction industries during a hearing in Atlanta in 1974.

As Federal Reserve officials begin raising interest rates from near zero in 2022, some prominent economists say a period of higher unemployment is all but necessary to create enough slack to hold down prices. They argue that inflation is driven by an overheated labor market.

Fed leaders say another path is possible because inflation is driven not by the labor market but by the collision between strong demand and disrupted supply chains. They believe the labor market is already out of balance as reopened businesses scramble to hire after the pandemic, and cooling demand could lead companies to simply cancel open positions rather than lay off workers.

Good luck played a role in the outcome. Supply chains were able to recover last year, and the economy avoided new shocks. A surge in immigration boosted output while easing worker shortages.

Earlier this year, when economists were puzzled about why interest rates weren’t doing more to slow the economy, Powell suggested that a surge in immigration might be masking the impact of tighter interest-rate policy. His underlying worry was that the effects of restrictive policies would show up gradually and then suddenly.

“What’s the hurry?” vs. “Why should we wait?”

Economic uncertainty threatens to end divisions at the Fed, where no official has dissented from a policy meeting since June 2022.

One camp, led by Fed Governor Michelle Bowman and Kansas City Fed President Jeff Schmid, worries that cutting rates too soon would reignite inflation or cause it to stabilize closer to 3% — well above their target.With unemployment at historic lows, the view from this camp is “What’s the rush?”

The camp is also skeptical of pessimism about the labor market. They point out that the recent rise in unemployment is driven by temporary rather than permanent layoffs and an increase in the number of people entering the job market, and that interest rates are only modestly restrictive.That means the Fed may not need to cut rates as aggressively as it wants.

The other camp is more concerned about complacency about slowing labor demand. With inflation-adjusted interest rates at their highest level in decades, the question these officials are asking is,“Why should we wait?”

"In a normal business cycle, unemployment goes up like a rocket and goes down like a feather," Chicago Fed President Goolsbee said in an interview. While the current cycle may be unusual, "it's a reminder that the job market has been cooling. It needs to stop cooling."

Many are braced for a rate cut next month, initially by the traditional quarter percentage point, but are unsure how quickly it should come down thereafter.The focus of the debate is how much higher current interest rates are than the "neutral" level that neither stimulates nor suppresses economic activity.

In September, Fed officials will need to give their forecasts for interest rates over the next three years. Minneapolis Fed President Neel Kashkari is uneasy about this, saying in an interview that he is very uncertain about "how tight policy is right now."

Barkin said he and Richmond Fed staff have surveyed hundreds of businesses to see if demand is weakening and whether they are prepared to cut jobs as a result. He has not seen that happening except in a few industries. “You could make a mistake by acting too forcefully or not enough,” he said.

Overall,The Fed faces two paths in the coming months. In one, officials could cut interest rates by a quarter percentage point over the next few meetings and then increase or decrease the size and pace of the cuts depending on how the economy performs early next year.

If the economy enters a more severe slowdown, the Fed could cut rates by larger half-percentage point increments to bring rates closer to 3% by next spring.

Goolsbee said that as a Fed official, in his view, the reason for taking gradual action is to provide optionality. But he said the disadvantage of gradualism is that when conditions change, there is not enough room for maneuver.

Some private-sector economists and former Fed economists, including those at JPMorgan Chase & Co. and Wells Fargo & Co., say evidence that the job market may be too slack should prompt officials to bring forward bigger rate cuts and abandon their long-standing path of gradualism.

Jay Bryson, chief economist at Wells Fargo, said the Fed is unlikely to do so unless “there’s a shock or a string of weak data that causes them to move faster.”