Fiscal policy likely to drag on growth: Fed paper

CHICAGO Mon Jul 2, 2012 1:03pm EDT

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CHICAGO (Reuters) - Fiscal policy in coming months and years is likely to tighten more quickly than would be expected given historical patterns, dragging down economic growth, a paper published Monday by the Federal Reserve Bank of San Francisco said.

A raft of spending cuts and tax increases set to come into force by the end of 2012 could push the United States off a so-called fiscal cliff and into recession, the Congressional Budget Office has projected.

But even if U.S. lawmakers avert a sharp contraction in fiscal policy, federal spending and tax rises will increasingly weigh on economic growth, starting this year and continuing for the next several years, the San Francisco Fed economists said in the paper.

That's a sharp turnaround from recent years, when federal spending was much more generous than what historical trends suggest should be expected in the aftermath of a recession, even such a severe one, the research shows.

"The tailwinds fiscal policy provided to economic growth during the Great Recession and the first few years of recovery have shifted direction," wrote Brian Lucking, a research associate at the San Francisco Fed, and Dan Wilson, a senior economist there, in the latest edition of the regional Fed bank's Economic Letter. "Going forward, the forecast calls for fiscal headwinds."

Fed Chairman Ben Bernanke and other Fed officials have warned about the damage that tight fiscal policy could have, even as the U.S. central bank takes unprecedented steps to loosen monetary policy to goose the lackluster recovery.

(Reporting by Ann Saphir; Editing by Chizu Nomiyama)

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