WHAT IS Soft Patch

Soft Patch refers to a period of economic slowdown amid a larger trend of economic growth. The term most often appears as a buzzword in the financial media and U.S. Federal Reserve statements to describe a period of economic weakness.

BREAKING DOWN Soft Patch

Typically, the term soft patch or soft spot describes a real GDP slowdown lasting two or three quarters.

Alan Greenspan popularized the term during his tenure as Federal Reserve Board Chairman from 1987-2006, although Federal Reserve publications as far back as the 1940’s contain uses of it. Despite its widespread usage, a precise, generally-accepted definition for what determines a soft patch remains elusive.

A soft patch may occur when GDP slows in response to a short-term rise in commodity prices, and will end when the economy begins growing again at a faster rate. Frequently, banks will cut interest rates in an attempt to spur an economy through a soft patch.

Soft Patch Scenarios

Temporary economic slowdowns occur frequently, and while any particular soft patch may not reliably predict a business cycle peak in the short term, longitudinal data shows that a soft patch preceded each of the 11 business cycle expansions in the U.S. economy between 1950 and 2012. Over time, a soft patch immediately preceded about half of all peak quarters.

A two-quarter soft patch occurs when the rate of GDP growth in the two most recent quarters is less than the growth during the quarter immediately prior. For instance, if GDP growth of an economy in the last quarter of 2016 was greater than the first and second quarters of 2017, the economy experienced a two-quarter soft patch. A three-quarter soft patch occurs when the three most recent consecutive quarters indicate less growth than in the quarter immediately prior. If GDP growth in the last quarter of 2016 was greater than the first three quarters of 2017, the economy experienced a three-quarter soft patch.

National Bureau of Economic Research data indicates that between 1950 and 2012, the U.S. economy experienced 69 two-quarter soft patches and 52 three-quarter soft patches, suggesting that soft patches are frequent economic occurrences. The frequency of such slowdowns reveal soft patches to be unreliable indicators of economic upswings, and at the same time they are not necessarily indicators of further economic slowing.