related to the balance between aggregate supply and demand. later i shall turn to concerns about imbalances in equity prices, the personal saving rate, the current account, and the household debt burden. a soft landing figure 1. a depicts a soft landing scenario, the graceful transition from the initial output gap to a sustainable growth path at full employment. a soft landing occurs if, as the level of output approaches potential, the growth of actual output slows to the growth of potential output just as actual output reaches potential. the line for potential output is, in effect, the runway. the line for actual output is like the path of a plane coming in for a soft landing - at least if you stand on your head while looking at the chart! steady inflation is generally one of the signs of sustainability. a simple model of inflation dynamics is that changes in inflation are induced by excess aggregate demand or supply, as reflected in the output gap. when actual output rises above potential, according to this model, the resulting excess aggregate demand leads to rising inflation. in the short run, supply shocks - including both relative price shocks and changes in trend productivity - can also affect inflation dynamics. but these effects are temporary. ultimately, inflation dynamics will be driven by the output gap. at some point in any expansion, therefore, a soft landing is the preferred path to preserve a healthy expansion. such a slowdown in growth is desirable because the alternative is higher inflation - indeed, continually rising inflation. looking back, most recessions have resulted from attempts by the policy authorities - yes, the fed - to reverse increases in inflation generated by overheating. a reverse soft landing figure 1. b depicts an alternative scenario in which the above - trend growth in the expansion phase has moved the economy beyond the point of its sustainable capacity to produce. policymakers in this case failed to execute a soft landing. what could they do in this case to best ensure the continuation of a healthy expansion? the answer is to engineer the closest possible approximation to a soft landing, one in which we glide to potential beginning from a position initially above rather than from below potential. because the convergence to potential is from above rather than below, i call this a “ reverse ” soft landing. in this case, because the economy is already operating beyond its sustainable capacity, the economy may not be able to avoid some acceleration in inflation as policymakers try to engineer the soft landing. therefore, the return to the potential output path has to be achieved in a sufficiently

. a reverse soft landing is the second - best option. otherwise, a hard landing may be unavoidable, despite the best efforts of policymakers. the upside of a hard landing is that it contributes to reversing imbalances and, afterwards, allows policymakers to aim once again at achieving a healthy, sustainable expansion, ultimately combining full employment, maximum sustainable growth, and price stability. it is useful to distinguish two broad classes of hard landings. the first involves the reversal of an imbalance between aggregate supply and aggregate demand. the classic example is the boom - bust scenario. the second class involves the unwinding of sector or market imbalances that either initiate a downturn in the economy or aggravate a downturn that would otherwise have occurred. a classic example of this genre is a stock market correction. i will focus first on the boom - bust scenario to complete my classification of paths to sustainable combinations of growth and the output gap. in the boom - bust scenario, depicted in figure 1. d, above - trend output growth during the expansion ultimately pushes output well beyond potential for a persistent period. the resulting overheating puts upward pressure on inflation. the monetary policy response to reverse the inflation often yields a decline in output, as depicted here, resulting in a period of economic slack and a reversal of the rise in inflation. this is the scenario from which we draw the lesson that timely, typically preemptive, policy restraint to avoid the excesses of a boom results in longer expansions and avoids unnecessary fluctuations in both output and inflation. where are we relative to potential and do we need to land? to identify whether the initial conditions today correspond to those in one of the panels of figure 1, we have to assess where output is relative to its potential and whether growth is above or below trend. this assignment is more difficult than usual because structural changes of uncertain dimension may have raised both the level and the growth rate of potential output. there is, for example, a consensus that the nairu has declined since the early 1990s. that decline translates into an increase in the level of potential output at any given time or a decline in the output gap for a given level of output. there is also a consensus that the rate of growth of potential output is higher today than during the twenty years preceding this expansion. however, the degree to which these two parameters have changed is not a settled issue. in particular, some think that the rapid growth and low unemployment rate of