What's Left To Fix The Economy If It Gets Worse?

With the U.S. economy stuck in neutral, analysts are busy adjusting their forecasts to include the possibility of another recession. Most aren't predicting another downturn, they're just saying that the odds have increased.

Meanwhile, policymakers at the Federal Reserve are divided about what to do next. Some are arguing for more aggressive action while others think that would be a mistake, according to minutes from their last meeting released on Tuesday.

Both the Fed and Congress are running out of ideas that they haven't already tried.

Economies usually snap back after recessions. However, recessions brought about by financial crises have their own rules, and they are much harder to bounce back from.

That's especially true of the last one, which ended two years ago. The housing sector is a mess; banks still have troubled mortgages on their books; and the job market remains bleak.

Vincent Reinhart, a fellow at the American Enterprise Institute and former director of monetary affairs at the Fed, says there's a 40 percent chance the U.S. will be in another recession within a year.

"And I think of that as we're flying the plane at a slower speed and closer to the ground; that is, that we're less resilient to bad shocks," he says.

Unconventional Approaches

One of the things that troubles economists like Reinhart is not just that the economy could be headed off course, but that there are few tools left to address that, should things get worse.

"The main problem we have — and that's about monetary and fiscal policy, if we have another recession — is that policymakers have already been there and done all that," Reinhart says.

Basically, the government has two methods of dealing with a recession. One is fiscal: The government spends money or cuts taxes to try to boost spending. The other is monetary: The Fed lowers interest rates, which is also designed to get people spending.

Currently, on the fiscal front there's little political will for a government spending spree because of concerns about a huge budget deficit.

Meanwhile, on the monetary side, the Fed has already pledged to keep short-term interest rates near zero until mid-2013. In recent years, the Fed has also tried an unconventional approach, buying more than $1 trillion in U.S. Treasury securities to push down long-term interest rates in the hope that might spur the economy.

Sacrifices And Adjustments

Mark Olson, a former member of the Fed's Board of Governors and now co-chair of a consultancy called Treliant, says there's not much more the Fed can do. "It leaves us on the horns of a dilemma, I'm afraid," he says.

Olson says the smartest move is also politically the hardest. Congress could pass a job stimulus program and, at the same time, reduce the long-term deficit through a host of painful cuts and tax increases. Doing that, he says, would assuage investors and get people spending again.

But Olson says what's economically rational is politically unlikely. It's been 70 years since the U.S. dealt with an economic hole this deep. And frankly, he says, as a country we're pretty spoiled.

"We're not accustomed to making the kind of sacrifices and adjustments that we'd been willing to do in the past in order to move forward," he says.

Targeted Spending Helps

Without the ability to do that, and without access to the traditional monetary levers, the country is left with a host of smaller ideas that try to tinker with the economy on the margins.

Karen Dynan, co-chair of the economic studies program at the Brookings Institution, says targeted spending, like extending payroll tax cuts and unemployment insurance, helps. But the fundamental problem remains the same: Some segments of the economy still aren't getting access to credit.

"Big businesses that can go to the bond market, they're not having trouble borrowing at low rates," she says. "But there are a lot of small businesses that are finding it difficult or impossible to get credit."

She says until someone can figure out how to get money flowing to all the places it needs to go, it'll be hard for policymakers to fix the problem.