Is The Federal Reserve Prepared For Another Economic Meltdown?

A little over 10 years since the 2008 Economic Meltdown ended, the growing threat of a new economic slowdown raises a troubling question: If we end up seeing another economic meltdown, are we prepared for it?

With interest rates low and their balance sheets still loaded with assets bought to fight the 2008 crisis, does the United States have the tools to respond? 

Overall, the U.S. economy looks strong, with unemployment at record low numbers and inflation running very close to the Federal Reserve’s 2 percent target. That said, there’s always a multitude of risks like a housing slump, a sharp decline in foreign demand for U.S. goods, an extended government shutdown that could put the expansion to an end.

“ I don’t believe we’ll see a crash in our near future as big as the one we saw in 2007-2008 in terms of the housing market. I think now the different lending standards have tightened and it is much harder to get a mortgage . You need to get through a harder approval process to make sure that you are buying a property that you can afford.” said Barak Sky, Realtor and President of The SkyGroup, Part of Long & Foster Real Estate Inc.

If we do end up seeing another recession, many believe the Federal Reserve will have arguably less firepower than in any previous recession. For example, we should consider its ability to stimulate growth by lowering interest rates.

In the early 2000s, when the tech bubble burst, the Federal Banks had to lower rates more than 5 percentage points to keep the unemployment rate from rising much above 6 percent. In the last economic downturn, amid the severe shock delivered by the financial crisis, even that wasn’t enough: Unemployment rose into the double digits despite interest-rate cuts of more than 5 percentage points.

Now, it looks like the neutral interest rate over the next few years — theFederal Bank’s starting point when the next downturn comes — could be as low is 2.5 percent. So unless it takes rates into negative territory, which seems unlikely, its response can be only about half as large as in the last two recessions.

“We should take advantage of the strong economy that we are having at this current moment and I don’t think that is going anywhere soon. With the interest rates at the lowest point it’s been in years, right now it’s a great time for the housing market and a great time buy a home,” shared Barak Sky.

So what can the Federal Reserve do to prepare for a possible meltdown? Many believe it needs to be much more aggressive in using the limited tools that it has. For one, if your medicine chest is nearly empty, you want to keep your patient as healthy as possible. That means cutting interest rates now to lower the unemployment rate even further. Doing so could also boost demand during any recession: If people come to expect stronger recoveries, they will be more likely to keep spending even in downturns.

“Lowering the rates will boost the economy and all its areas in so many ways. First it will help decrease mortgage rates, that will eventually bring more buyers to the market combined with lower prices for real estate that will keep the growth” added Barak Sky.

A pre-commitment to strong growth could also help. In the last recession and ensuing slow recovery, the Fed treated its low-interest-rate policy largely as an emergency step that would be removed within the next year or two.

Instead, experts believe the Federal Reserve should publicly commit now to maintain maximum stimulus after a recession until the unemployment rate falls below 3 percent, as long as the year-over-year core inflation rate remains below 2.5 percent.

Such a promise, much stronger than any used or even suggested during the last recovery, would help minimize the damage and speed up the rebound.