With the recovery of the U.S. economy flagging, economists are expecting renewed efforts from policymakers to boost the economy.

“There is no denying that the U.S. economy has stumbled and the recovery is at risk,” notes BMO Capital Markets in a research note published today. CIBC World Markets agrees, saying, “It’s increasingly evident that America’s economic recovery is simply not good enough. Not good enough to vanquish unemployment, power consumption, withstand fiscal tightening, and protect against deflation risks down the road.” BMO notes that this could likely spillover and impact the Canadian economy, too.

“Something must be done, and in the week ahead, it’s Ben Bernanke’s FOMC that will be looking at what role it can play in that effort,” CIBC adds. However, it says that a move to reduce the rate paid on deposits of excess reserves held at the Fed, “would have a trivial impact”, and is unlikely to boost credit flows.

“Quantitative easing, printing even more money to buy securities, rather than winding down the Fed’s balance sheet, can help defuse deflation expectations if done with sufficient aggression,” CIBC suggests, although it cautions that the impact would likely be “dulled to the extent that the money multiplier remains low, and the extra liquidity fails to spark a surge in lending and broader money aggregates.”

BMO agrees that there’s not a lot the Fed can do with conventional policy tools to restart the recovery. “In normal recessions, the Fed eases monetary policy, lowering interest rates and steepening the yield curve. This reboots housing and other interest-sensitive spending, which leads the economy out of recession. This time, given that the Fed did not cause the recession, the Fed cannot end the recession just by lowering interest rates and steepening the yield curve, even through quantitative easing.”

That said, it adds that the Fed has “no alternative”, but to become even more accommodative through additional quantitative easing, but that the federal government must also “engage in another round of fiscal stimulus”.

“Politically, the battles will continue, but this latest jobs report will likely push the Republicans into agreeing to federal measures to assist further the suffering state and local governments,” BMO says.

It says that tax increases, even on the rich, should be ruled out (although in the future it may have to introduce a value-added tax and cut services to help combat deficits). “In the short-term, however, the Congress and the White House have no choice but to take actions that will boost employment and mitigate the burden of the unemployed.”

CIBC points out that the Fed can agree to monetize additional Treasury debt that to finance more spending or tax cuts. Or, it says, “it could print money to buy foreign currency, driving the dollar down in the process.”

“But before any of this is even considered, the Fed has to come to a consensus that laissez faire won’t work,” CIBC suggests. “That will require a sea change in thinking.” New appointees to the Fed might help that change happen, it says, but continued weakness in the job market “would be even more likely to do the trick”, it says.

“By early 2011, either fiscal tightening will be pushed off, or the Fed will be reaching for unconventional tools to get the economy moving again,” it concludes.

IE