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Hilsenrath Warns Fed Is Out Of Ammo, "Policy Makers Resorting To Backup, Backup Plans"

As the U.S. economic expansion ages and clouds gather overseas, policy makers worry about recession. But, as WSJ's Jon Hilsenrath warns, their concern isn’t that a downturn is imminent but whether they will have firepower to fight back when one does arrive. "The world economy is like an ocean liner without lifeboats,” economists at HSBC Bank explained, and as looming threats are a reminder that the slow-growing global economy is just a shock away from peril, with rates already at zero, Douglas Elmendorf, the recently departed director of the CBO, warned, "policy makers are thinking about their backup, backup plans."

As The Wall Street Journal reports,

Money has been Washington’s primary weapon in the decades since British economist John Maynard Keynes proposed aggressive government spending to battle the Great Depression. The U.S. generally injects cash into the economy through interest-rate cuts, tax cuts or ramped-up federal spending.


Those tools could be hard to employ when the next dip comes: Interest rates are near zero, and fiscal stimulus plans could be hampered by high levels of government debt and the prospect of growing budget deficits to cover entitlement spending on retired baby boomers.

Even so, looming threats are a reminder that the slow-growing global economy is just a shock away from peril.

Japan’s economy contracted in the second quarter and Europe recorded lackluster growth. China’s slowdown, meanwhile, appears more severe than global policy makers initially realized and a currency devaluation there might spur trade frictions.


With the U.S. expansion entering its seventh year, policy makers are planning how to respond to the next downturn, which history shows is inevitable. The current expansion is now 16 months longer than the average since World War II, and none has lasted longer than a decade.


“The world economy is like an ocean liner without lifeboats,” economists at HSBC Bank wrote in a recent research note.

In the next downturn, former Fed Chairman Ben Bernanke said in an interview, the tools of government will be “more limited than usual, but they’re not zero by any means.”

The Fed, for example, could experiment with negative interest rates. A recession also could force Congress and the White House to bridge Washington’s partisan divide to strike a deal that pairs short-run stimulus with long-run plans to reduce the deficit.


“This is a very live question,” said Douglas Elmendorf, the recently departed director of the Congressional Budget Office. “Policy makers are thinking about their backup, backup plans.”

Many economists believe relief from the next downturn will have to come from fiscal policy makers not the Fed, a daunting prospect given the philosophical divide between the two parties.

At issue is how much the U.S. can afford to borrow and spend to goose the economy out of the next recession. The experience of the past recession has set off sharp disagreement among economists.


“If there’s another recession, there will be pressure to expand the deficit fairly rapidly to a level that is unprecedented in modern time,” said Stephen King, senior economist at HSBC and author of the report on the global economy’s lack of fiscal lifeboats.


No one knows how much U.S. debt can grow without triggering an increase in inflation and interest rates that would hobble investment and growth. “We don’t have that much experience with countries carrying debt like the level the U.S. has right now,” said Mr. Elmendorf, the budget analyst.


Even if it were clear that the U.S. could afford to boost spending or cut taxes, partisan disagreements over Mr. Obama’s 2009 stimulus spending stand in the way of a consensus on the benefits of fiscal policy in a downturn.


Compromise has been elusive. After Republicans won control of the House in 2010, the White House sought, unsuccessfully, a deal to raise revenues and curb long-run growth in spending, in exchange for a short-run stimulus.


The next downturn could return the two sides to the bargaining table. But lawmakers will have less room to maneuver “because the entitlement side hasn’t been addressed,” Mr. Corker said. “We haven’t dealt with even the most basic elements.”

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So taking Hilsenrath as The Fed's unofficial mouthpiece, this note suggests rates are coming off the zero-bound no matter what as a lack of 'tools' in a downturn trumps the risk of causing a downturn to start with.