A man holds a new Indian two thousand rupee banknote for photographs outside the Reserve Bank of India (RBI) headquarters in New Delhi, India. (Photographer: Anindito Mukherjee/Bloomberg)

Your Central Bank Can’t Save You Next Time

(Bloomberg Opinion) -- Warning: Steep grade ahead.

When the U.S. economic expansion reverses, and when emerging markets start to slip faster, the world’s central banks may not be able to help.

Of course, the next recession may not be another “great recession.” And I’m not predicting it’s imminent. For now the Federal Reserve is continuing to raise interest rates on schedule, and Europe is trimming stimulus while the U.K. and Canada are nudging rates higher. Depending on your perspective, Japan is staying easy or tapering by stealth. But downturns have a way of creeping up on us.

In recent recessions, governments have cut interest rates to keep their economies chugging along, and even have bought bonds to stimulate growth. But central banks don’t have close to enough ammunition to fight another serious slump anytime soon.

Those who make and watch monetary policy knew this in the abstract, as sort of a “something to think about for the future.” That changed last week. Suddenly the topic feels urgent. Good.

The Bank for International Settlements fired a shot on Sept. 23 when top official Claudio Borio said that the global picture is shaky and that officials may find themselves powerless to respond. Writing in the BIS Quarterly Review, Borio pointed to market ructions as a vulnerability for the world economy and said “there is little left in the medicine chest.”

A few days later, at Columbia University in New York, central bank hall-of-famers fretted about the consequences of another slump. Will a 2008-style response be forthcoming from policy makers? Bill Dudley, just retired as president of the New York Fed, wondered. Brian Sack, who ran the markets desk under Dudley, was blunt: The most significant issue is the inability to ease credit in the way needed to address large shocks. Current policies are insufficient, and there’s a risk of decades of inadequate measures and sluggish recoveries.

Sack, now chief economist at D.E. Shaw & Co., recalled preparing projections for the Federal Open Market Committee in early 2009. Staff math suggested the economy and financial system needed the benchmark rate to be cut deeply into negative territory — to about minus 6 percent!

That wasn’t going to happen, so they tried to replicate it with prolonged asset purchases, special lending ideas and a panoply of crisis-era measures. Most of these contentious steps were a product of not being able to go negative. Unless there can be an adult conversation in America over negative interest rates — the counterintuitive idea of borrowers getting paid and savers dinged — the nation is condemned to a cycle of crisis, panic, repeat.

Writing in the Wall Street Journal last week, Harvard professor Martin Feldstein foreshadowed a “long, deep downturn” in the U.S., faulting the high level of asset prices as the likely culprit. The Fed has little room to maneuver.

Will central banks get back to normal — wherever and whatever that is — before the cycle ends? It’s doubtful.

One more sobering thought: Quantitative easing blurs the lines between fiscal and monetary policy, a point made by Francesco Papadia, an alumnus of the European Central Bank whose book with Tuomas Valimaki was the subject at Columbia. Central banks aren’t supposed to do fiscal stimulus.

They got away with it after 2008, but only because the calamity was so grave. Would another chairman be able to pour Fed dollars into government bonds like Ben Bernanke did? I hope we never have to find out.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Daniel Moss writes and edits articles on economics for Bloomberg Opinion. Previously he was executive editor of Bloomberg News for global economics, and has led teams in Asia, Europe and North America.

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