With its policy interest rate still at near-zero percent, and deficits much smaller than was seen in the wake of the financial crisis, the Federal Reserve has little room to maneuver when the next recession comes.
On interest rates, as a practical matter, the Fed cannot go lower than zero. After all, why deposit money in a bank at all? Such a move would risk a bank run nationwide unless it was coupled with banning cash, and even then the public outrage over the theft would likely make such a move untenable. As a policy tool, then, interest rates will not be available if the Fed does not hike rates soon.
On quantitative easing, the supply of new treasuries to purchase is not what it used to be. In its heyday of QE, the Fed was buying treasuries at a rate of $45 billion a month, or $540 billion a year. Now, that total would be greater than the deficit for all of 2014, which was $484 billion.
Granted, $484 billion is nothing to sneeze at; and yet, in today’s bond market, it isn’t all that much. Demand for treasuries remains high, particularly with the ongoing correction in China and depression in Europe. Interest rates have been dropping as a flight to the relative safety of treasuries has ensued.
Barring a recession eating up revenues and driving up deficits, any new Fed purchases of treasuries would seem to have to be much smaller than before. The central bank might offset that by purchasing more mortgage-backed securities (it holds $1.7 trillion now).
Not that it would do any good. In total, the Fed’s unprecedented quantitative easing increased its holdings of treasuries and agency-owned mortgage-backed securities by about $3.4 trillion since August 2007. Most of that, $2.4 trillion, is still sitting in a vault as excess reserves held by financial institutions.
On the fiscal side of the equation, political paralysis would likely stymie any efforts by the lame duck Obama administration to push any new stimulus spending program through the Republican-led Congress, and any efforts by Republicans to, say, cut taxes, something President Barack Obama would surely veto.
But, the U.S. is not alone in this malaise. The national debts of the U.S., Europe, and Japan skyrocketed in the last recession. These additional costs pose extra burdens on economies already weak, and make any new, large stimulus packages politically untenable.
Particularly when the last round of spending and borrowing was so unsuccessful. U.S. annual growth has averaged just 2.06 percent since 2010, well below the postwar average, representing the worst recovery since the Great Depression.
Yet, the U.S. is still very much on the emergency footing of the financial crisis of 2008. Now there is no room to engage in countercyclical policy if and when recession strikes.
That is, unless policymakers start normalizing right now, cognizant that they may have waited far too long to act. Already, with markets in the U.S., China, Europe, and elsewhere dropping, many observers are warning that hiking rates now would provoke a recession.
And yet, the next recession is inevitable. The U.S. economy averages one every six to seven years under normal conditions; and, well, we’re due for another.
If the Fed starts normalizing interest rates at its next meeting in September, it runs the risk of being blamed when the recession really does hit. And if it does not, it runs the risk of having no bullets to fire should the next recession come sooner than anyone is predicting.
Robert Romano is the senior editor of Americans for Limited Government.
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