With rates low, Fed officials fret over next US recession

new york/los angeles — Federal Reserve policymakers are fretting that they could face the next US recession with an arsenal of policies little different from that used in the last downturn but robbed of much of their punch because interest rates are still low.

In the midst of an unprecedented leadership transition, Fed officials are publicly debating how to prepare for the next downturn. Should they scrap their approach to inflation targeting? How big of a balance sheet should they retain? How much further can they raise interest rates and still keep the economy on a growth path?

All this comes against a backdrop of an unexpectedly large boost from tax cuts and government spending that will drive up deficits, leaving less room for a fiscal rescue in the next recession. “The thing that keeps me up at night is that when that next recession happens, and hopefully not for a long time, I don’t think we have as strong a toolkit as we would like to have to respond to that,” San Francisco Federal Reserve Bank President John Williams said on Friday at a Town Hall Los Angeles event.

To pull out of the 2007-2009 recession, the Fed slashed shortterm interest rates to near zero and bought $3.5 trillion in bonds to push down longer-term borrowing costs. Since late 2015 it has gradually reversed course. Its key rate is now in the range of 1.25 to 1.5 per cent, and the Fed expects to end this year with rates between 2 per cent and 2.25 per cent.

With an ageing population slowing the economy’s growth potential, the Fed projects it can raise rates only to about 2.75 per cent before borrowing costs will really start to brake the economy. Before the recession, most economists thought that neutral level was closer to 4 per cent.

With rates so low, there would be little room to cut them to provide stimulus when the world’s largest economy, which is heating up, eventually turns around. “We would be better off, rather than thinking about what we would do next time when we hit zero, making sure that we don’t get back there. We just don’t want to be there,” Boston Fed President Eric Rosengren told a New York conference of economists.

Rosengren, one of only a few sitting policymakers who also served during the last downturn, said the expanding US deficits could further erode the government’s ability to help curb any future recession.