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U.S. Policy Makers Worry about Recession Firepower
Thursday, August 20, 2015 6:35 AM

Money has been Washington’s primary weapon. 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, fiscal stimulus plans are hampered by high levels of government debt and there is growing budget deficits to cover entitlement spending on retired baby boomers.

Few economists believe the U.S. is near a recession. 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. All three are the chief importer of U.S. goods.

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

In the future the Fed could experiment with negative interest rates, essentially charging banks for depositing cash rather than lending it to businesses and households. However, economic theory suggests negative rates prompt businesses and households to hoard cash, essentially, stuff it in a mattress.

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.

The Fed’s strategy of keeping interest rates low well into an expansion is intended to help avoid a relapse into recession. Fed Chairwoman  Janet Yellen has described low rates as insurance against another downturn. That is another reason officials intend to move slowly once they begin nudging up rates.

The next downturn could further expand Fed bondholdings, but with the central bank’s balance sheet already exceeding $4 trillion, there are limits to how much more the Fed can buy.

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.

Republicans doubt federal spending expands the economy, and they seek to shrink rather than grow government. Democrats, meanwhile, say government austerity hobbles the economy, especially in a downturn.

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.

Federal debt has grown to 74% of national output, from 39% in 2008. To restrain short-term budget deficits, Congress and the White House agreed earlier this decade on a mix of spending cuts and tax increases. In all, total state, local and federal government spending, adjusted for inflation, shrank 3.3% since the recovery began in 2009, compared with an average increase of 23.5% over comparable periods in past postwar expansions.

International Monetary Fund economists warn against undercutting growth by imposing austerity programs when a debt crisis isn’t imminent.


The Wall Street Journal, 18 August 2015