Federal Reserve officials and top economists have been debating which tools will work best to fight future recessions, and a clear consensus is forming: They are going to need lawmakers’ help.
Interest rates are mired at lower levels than in past economic expansions, part of a long-running trend that looks unlikely to reverse anytime soon. That leaves central bankers with less room to goose the economy in a downturn — and raises the possibility that they could exhaust their monetary ammunition in a serious slump.
Lael Brainard, a Fed governor, on Friday issued one of the clearest calls for proactive congressional action, while speaking at a conference in New York held by the University of Chicago Booth School of Business.
“Just as monetary policymakers are actively reviewing their tools and strategies, now is the time to undertake a review of fiscal tools and strategies to ensure they are ready and effective,” she said. Fiscal policy is made by lawmakers with taxing and spending authority, and Ms. Brainard said the design of “more automatic, faster-acting” responses in that arena would take work.
Central bankers are hoping that both Congress and state and local authorities will step up come the next recession, helping to offset any economic pain. Monetary policy remains a powerful tool for fighting downturns — and officials plan to use mass bond-buying and promises to keep rates low for longer to make up for their lost room to cut rates. But central bankers could run out of the ammunition they need to quickly return the economy to health.
The Fed has long used the federal funds rate as its primary tool for guiding the economy, and it is now set in a range of 1.5 percent to 1.75 percent. It was above 5 percent heading into the 2007 to 2009 recession.
“Long-term interest rates are likely to be much lower going into the next downturn than they were going into any recession in the past 75 years,” a set of top economists wrote in a paper prepared for the conference. “This will clearly limit the potential for old and new monetary policy tools to ease financial conditions and bolster economic outcomes.”
Fed Chair Jerome H. Powell often tells lawmakers that the Fed will need their help going forward. During testimony last week, he said that “it would be important for fiscal policy to help support the economy if it weakens.”
But Ms. Brainard’s implication that Congress should be thinking about how to make fiscal tools more automatic goes a bit further. The idea that Congress could pre-commit to taxing or spending policies that would kick in as soon as the economy starts to slow has increasingly been a centerpiece of Fed and academic economic research.
One such proposal is the so-called Sahm Rule. Created by Claudia Sahm, a former Fed economist, it would use a pronounced jump in the unemployment rate to trigger a fiscal response such as stimulus payments to households.
Ms. Brainard’s colleague, Mary C. Daly, president of the Federal Reserve Bank of San Francisco, has also made a case for government spending policies that kick in immediately.
Central bankers “face greater uncertainty about the impact of our tools and their ability to achieve our goals,” she said in a speech earlier this month. “Fiscal policy will need to play a larger role in smoothing through economic shocks,” and “expanding the array of automatic stabilizers that form part of the social safety net can help mitigate the depth and duration of economic downturns.”
Ms. Brainard did not endorse any specific set of policies, but pointed out that while “monetary policy is powerful but blunt,” fiscal policy can be used to tackle precise problems — important when a big share of households “have low liquid savings and are particularly vulnerable to periods of unemployment or underemployment.”
While some congressional committees have looked into supplementing or strengthening existing spending programs that work to counter recessions — like unemployment insurance, which pays out more when times are tough — they have not been beefed up since the Great Recession.
Some economists worry that a divided Congress would be slow to coalesce around a big spending package, like the crisis-era American Recovery and Reinvestment Act, to help right the economy in a future downturn.
The onus does not fall entirely on lawmakers. As Ms. Brainard suggested, the Fed itself is thinking about how to make monetary policy faster-acting in times of crisis.
Part of the reason that the recovery from the Great Recession was so plodding is that monetary policy responded only slowly, many economists think, and then took a long time to seep through the financial system.
“We should clarify in advance that we will deploy a broader set of tools” to right the economy, Ms. Brainard said. “To have the greatest effect, it will be important to communicate and explain the framework in advance so that the public anticipates the approach and takes it into account in their spending and investment decisions.”
It is not a foregone conclusion that the Fed will find its powers depleted come the next expansion. Ben S. Bernanke, the former chair, estimates that tools including bond-buying will be enough. Proactive promises like the ones Ms. Brainard raised could help, too.
But if such policies fall short, the consequences could be serious. Europe and Japan’s experiences have showed that weak economic recoveries can lead to slumping inflation. They also come at a huge human cost, as workers struggle to find jobs and experience drawn-out periods of weak wage growth.
“Monetary policy should not be the only game in town,” according to the paper presented at the conference, written by a group of economists including JPMorgan Chase’s Michael Feroli and Citigroup’s Catherine Mann. The group wrote that “monetary policymakers should be humble about how much can be expected” from new monetary policy tools.
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