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Fed has little room left to revive growth

Maybe Ben Bernanke should be asking the questions of Congress, not the other way around.

When the Federal Reserve chairman heads to Capitol Hill Tuesday to brief lawmakers, the session is likely to be devoted largely to questions about how to keep the U.S. economy from slipping into recession.

While central bankers are considering ways to ease monetary policy even further, they can do little more than watch as Congress heads for a potentially ruinous year-end "fiscal cliff" of tax hikes and automatic spending cuts.

Bernanke might better use his time asking Congress what it will take to break the logjam. Some budget analysts say the answer is pretty simple.

“The framework is no mystery,” said Brookings Institution economist Alice Rivlin, a former White House budget director in the Clinton administration. “Everybody who has worked on this problem has come up with the same thing, and so everybody knows what the parameters are. It's just a question of saying, let's hold hands and jump together.”

With economic indicators around the world pointing to a widening slowdown, pressure has increased on the Fed to embark on a third round of easy-money policies to spur growth. Central bank forecasters recently cut their growth projections but still expect the slowly growing U.S. economy to avert recession.

Last month the Fed cuts growth projections for this year to between 1.9 and 2.4 percent, down from the range of 2.4 to 2.9 percent  projected in April. The central bank doesn’t expect GDP to reach 3 percent again until at least 2014.

After clocking in at 3 percent pace in the final quarter of last year, the economy slowed to a 1.9 percent rate in the first quarter of this year. Since then, the job market has weakened again. House prices have hit bottom in many parts of the country, but the housing market is still much weaker than expected some four years into an economic recovery.

With jobs hard to come by and Congress all but AWOL until the November elections, consumers – who drive some 70 percent of gross domestic product - are pulling back. Retail sales in June fell for third month in a row – the first time that’s happened since the end of 2009.

“Since consumer confidence is linked to job gains and the unemployment rate, the resulting slowdown in payroll increases is turning into a real economic problem,” said Joel Naroff, chief economist at Naroff Economic Advisors.

The persistent political stalemate over the fiscal cliff – along with the possible impact on tax rates - is creating wider uncertainty for both consumers and businesses. Corporate profit growth is slowing. S&P 500 earnings for the second quarter now are expected to rise just 5 percent from a year ago, down from an estimate of 9.2 percent at the beginning of April, according to Thomson Reuters data.

Some analysts think the U.S economy as already entered a recession.  At the ECRI, a forecasting firm that concentrates on tracking the ups and downs of the business cycle, co-founder Lakshman Achuthan believes the U.S. is in recession. Among other signals, Achuthan points to a slowdown in income growth that has sapped consumer spending – despite the Fed’s massive pump-priming.

“The unfortunate reality is that the Fed is ‘pushing on a string,’” Achuthan wrote in in a May report predicting that another down cycle had begun.

Since the financial collapse of 2008, the Fed has twice sought to revive the US economy by flooding the financial system with $2 trillion in cash by buying bonds on an unprecedented scale. More recently, the central bank has sought to lower longer-term rates by swapping short-term Treasuries for longer-term debt. Those moves have driven lending rates to near zero, with little lasting impact on growth.

A third round of easy money bond-buying could help prop up stocks, as ultra-low interest rates send investors looking for higher return. But rates already near zero, many analysts argue that the Fed has little room left to make money cheaper to borrow. About all the central bank can do is to promise to keep rates low for even longer than it’s already committed to.

There’s widespread agreement, though, that the Fed is powerless to prevent the damage inflicted by Congress if lawmakers fail to steer tax and spending policies away from the looming cliff.

“If the U.S. were to jump off the fiscal cliff this would be a major macroeconomic event,” said IMF chief economist Olivier Blanchard. “This would probably kill growth in the US next year.”

On Monday, the IMF cut its forecast for global economic growth and warned that slowdown could accelerate if policymakers in Europe don’t move quickly enough to head off their own tax and spending crisis.

The statement echoed comments last week by St. Louis Fed President James Bullard, who told a group of bankers in London last week that the European crisis is the most pressing issue facing the global economy.

"The crisis is contributing to recession, adding a dragging factor on U.S. and Asian performance,” he said. “There is a financial sector dimension which periodically threatens to expand into a more generalized financial crisis," Bullard said.

European officials continue to flail at a 2-year-old debt crisis that has defied dozens of proposed solutions. With details still murky over a 100 billion euro ($122 billion) agreement to bail out Spanish banks, euro zone finance ministers gather Friday to try to resolve a long list of unanswered questions.  One of the toughest question that remains is whether bond investors will have to wait in line behind the European bailout fund should Spain default on its debtts.

"If you underpin your banks you are able to buy time. But in my view it will be just buying time. It's difficult to see how Spain can actually avoid a full-blown bailout," said Gianluca Ziglio, an interest rate strategist at UBS.

Madrid recently announced its plans to proceed with its own fiscal cliff, a package of 65 billion euros ($80 billion) in tax increases and spending cuts promised as a condition for the bank bailout.

Europe’s central bankers have responded with their own easy money policies, recently pumping  a trillion euros in cheap loans into to the banking system But European bankers, hunkering down to weather the gathering storm, have pulled back on lending, which has deepened the recession.

The slowdown in Europe is now spreading to Asia, where slack demand from one of its biggest export markets has helped cool China’s booming economy. That, in turn, has begun to slow the economes of smaller Asian countries that rely heavily on Chinese purchase of components and raw materials

Beijing has recently announced a series of stimulus measures to revive growth. But some analysts fear those measures won’t be enough to offset the momentum of a wider global slowdown.

 “Policymakers are behind the curve in Europe, China and U.S., which means that the slowdown is upon us and will continue to accelerate, “said John Brynjolfsson, managing director of a hedge fund called Armored Wolf.