Bold Fed still needs fiscal help

By Burton Frierson - Analysis

NEW YORK (Reuters) - No matter how bold the Fed's unprecedented plan to revive the U.S. economy, it is likely to take a stimulus package of as much as a trillion dollars to halt a precipitous slide into deflation.

The U.S. Federal Reserve cut interest rates to the bone on Tuesday in its efforts to halt the economy's rapid descent and said it would employ "all available tools" to end a year-long recession.

But the failure of its efforts so far to revive lending in the shaky U.S. financial system show the need for government spending to take over where monetary policy faces limits.

"In a situation as dire as this, monetary policy on its own is not adequate to the job," said Nigel Gault, director of U.S. economic research at Global Insight in Lexington, Massachusetts. "The federal government can borrow, and the federal government can effectively step in and be a spender of last resort."

"If we did nothing on the fiscal stimulus side, it would be a much bigger risk of getting into a full-fledged deflationary spiral."

Gault said he would like to see stimulus of about $700 billion to $800 billion over the next three years.

The United States last endured a period of deflation during the Great Depression of the 1930s.

Policy makers and economists fear this phenomenon of downwardly spiraling prices, earnings and economic activity because it is perhaps the most difficult problem to fix.

In such periods, banks stop lending, consumers stop spending and businesses cut investments and lay off workers.

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U.S. President-elect Barack Obama has repeatedly raised hopes of those calling for a substantial economic stimulus, promising a massive public works program to lift the U.S. economy out of recession.

On Tuesday, he warned that the central bank was running out of traditional tools for fighting recession and said other branches of government needed to step up to help.

"That's why the economic recovery plan is so absolutely critical," he said.

The Wall Street Journal reported on Saturday that Obama's team is considering a plan that might reach $1 trillion over two years.

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