Is the Fed out of bullets?

By Chris Isidore, senior writer


NEW YORK (CNNMoney.com) -- Economists are more nervous about the chances of another recession. And one of biggest fears is that the Federal Reserve may have run out of bullets to fight another downturn.

"They do have some ammunition left, but it's not going to pack a lot of punch," said Mark Zandi, chief economist with Moody's Economy.com.

Most economists aren't yet predicting that a double dip recession is imminent. But financial problems in Europe led to a sell-off in U.S. stocks in the past six weeks. Weaker-than-expected readings on job growth and retail sales have added to concerns that the recovery is stalling out.

"Whenever the next recession comes, it is very important that policymakers have had the opportunity to reload their gun to fight the downturn," said Lakshman Achuthan, managing director of Economic Cycle Research Institute. "Today it's not clear that there's a lot more policymakers can do."

The typical first step to spur a faltering economy is for the Fed to cut the cost of borrowing money in order to encourage spending.

But the federal funds rate, its key interest rate used as a benchmark for a wide range of consumer and business borrowing, is already near 0%. Fed policymakers are widely expected to leave rates near zero at the conclusion of their two-day meeting on Wednesday.

Longer-term rates set by the market, such as Treasury yields and mortgage rates, are also nearing historic lows. So the Fed can't make money much cheaper.

Achuthan said he is worried that neither the Fed nor Congress have the resources and political will necessary to stimulate the economy if that's needed.

He said the situation harkens back to Fed Chairman Ben Bernanke's facetious suggestion back in 2002 that the Fed might one day need to drop large bundles of cash from helicopters in order to spur spending when it exhausted other options.

"I wonder if it's coming back on the table," Achuthan joked.

But even cheaper money might not be enough to encourage increased borrowing and spending in the current uncertain economic climate.

Paul Ashworth, senior U.S. economist for Capital Economics, said weak demand for credit from businesses and consumers, rather than tight supply, is what is causing borrowing to continue to fall.

"It's hard to do know what [the Fed] can do to encourage spending at this point other than flooding the economy and banking systems with money," said Ashworth.

The Fed pumped trillions into the economy over the past two years through the purchases of non-traditional assets, such as long-term treasuries and mortgage-backed securities.

Some look at the Fed's balance sheet and worry that it could be leading to asset bubbles and inflation down the road. Kansas City Fed President Thomas Hoenig has been pushing for the Fed to start raising rates and reduce the size of its balance sheet.

Even if other Fed policymakers aren't echoing Hoenig's calls, there are enough inflation hawks at the Fed to keep the central bank from resuming those asset purchases, said Lyle Gramley, a former Fed governor, a consulting economist with the Potomac Research Group.

"Unless the economy is facing utter disaster, getting the Fed to reactivate that program will be a very tough sell," he said.

And despite the growing worries about the economy, Fed officials have to be careful not to raise too many alarms. Too much attention to problems that have arisen since the Fed's last meeting on May 9 could be more dangerous than ignoring the growing threats, according to experts.

Zandi said if the Fed were to hint it is even considering another round of asset purchases, "it would be counterproductive."

"It'd spook the hell out of the market," he said. To top of page

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