Policymakers in Europe and the United States facing weak growth and painfully high unemployment are struggling with the issue of whether additional monetary stimulus could do more harm than good.

As the annual Jackson Hole gathering came to a close on Saturday and some of the world's most important central bankers headed back home, a former vice chairman of the U.S. Federal Reserve summed up the key issue confronting the prestigious policy retreat.

"What is holding the economy back? Why is it that we've had such incredibly accommodative monetary policy for so long (but) we've had so little growth? I think it remains a puzzle," said Donald Kohn, who is now a senior fellow at the Brookings Institution think tank in Washington.

Fed Chairman Ben Bernanke, citing "grave" concerns about stagnation in the labor market in remarks that were seen as advancing the case for another round of bond purchases by the U.S. central bank, talked about headwinds obstructing a recovery that included the debt crisis in Europe and U.S. fiscal policy.

European Central Bank President Mario Draghi canceled his attendance at the conference to stay home to prepare for a meeting on Thursday, at which he may advance a controversial plan for the ECB to buy Spanish and Italian government bonds to win time for the region to tackle its festering debt crisis.

Adam Posen, who finished his final day as a member of the Bank of England's monetary policy on Friday and is a powerful advocate for more forceful central bank action, asked the same question as Kohn: "Why has all this lower short-term interest rates failed to make the economy go go go?"

But he scornfully blamed "defeatism" by central banks concerned about interfering in the proper functioning of markets and damaging their credibility. He argued that policymakers in Europe and the United States should waste no time in extending asset purchase programs to spur growth.

"The idea that this is somehow a pristine, virgin central bank that would be tainted forever by intervening ... is a prehistoric way of thinking," he said.

A Reuters poll this week revealed a strong expectation that Draghi will expound on plans for the ECB to buy government debt to reduce crippling Spanish and Italian borrowing costs.

But the ECB is not likely to set a cap, or a defined level at which it will step into the market, on those yields, according the survey.

Economists were divided over whether the bank will cut its main refinancing rate from 0.75 percent to a record low of 0.5 percent next week. An October rate cut instead looked equally likely.

A Reuters Poll also found the Bank of England is likely to beef up its 375 billion pound quantitative easing program with a final extra 50 billion pound round of bond purchases - but not until November.

LIMITS TO THE POWER OF POLICY

From the other side of the debate, Lawrence Lindsey, who was an adviser to former Republican President George W. Bush, told central bankers to display some "modesty" about the limits of their authority and power.

Bernanke has enraged many Republicans for the Fed's aggressive action to prop up the U.S. economy, including the purchase of $2.3 trillion worth of Treasury and mortgage-backed bonds. Critics claim the Fed's bond buying has enabled profligate spending by Congress and Democratic President Barack Obama.

"We should recognize that caution in respect to the views and insight of others in society is the right way to go," Lindsey said.

A hotly debated paper presented on Saturday discussed the damage done to U.S. households by the collapse in the housing market, raising the question of what monetary policy could do to help people whose assets have been wiped out and who were now saving like crazy to rebuild them.

Alan Blinder, another former Fed vice chair who now teaches economics at Princeton, ticked off the two most blatant culprits for why the U.S. economy continued to struggle: government spending cuts and the drag from the depressed housing market.

Kohn was not convinced that various headwinds fully explained why growth had been weak for so long, and wondered whether the unusually low level of interest rates was impacting economic activity in a way that was not understood.

"We keep trying to bring spending from the future into the present with lower and lower interest rates. ... There is a lot we don't understand about what is going on," he said.

A paper presented by Edward Lazear, another former Bush aide, sought to tackle whether the rise in U.S. joblessness was simply due to economic weakness or whether it reflected a fundamental structural shift in the economy.

The question is essential because monetary policy would be traditionally aimed at cyclical unemployment, while structural changes demand intervention by the government to do things like improve skills training or change incentives to get people back to work.

Lazear concluded that most of the rise in U.S. unemployment was probably cyclical, but he left some unconvinced.

"I think it is kind of the elephant in the room for this conference - whether the U.S. economy went through some sort of structural shift associated with this very large financial crisis," said St. Louis Federal Reserve President James Bullard, who has publicly questioned the need for more Fed action.

"It sure looks like the economy was on one trend pre-crisis and it is on a very different trend post-crisis," he added. "I think the longer this goes on the stronger the evidence will be that we're on a different trend (and) ... it does have policy implications," he said.

Reservations were also voiced by several politically connected Republican economists who could be influential if their party's candidate for president, Mitt Romney, wins the White House on November 6.

"It really is a fiscal problem," said Martin Feldstein, a Harvard economist who is seen as a possible candidate to lead the Fed if Romney wins, as he pointed to the harm done by the housing collapse. "None of that is going to be fixed by monetary policy, and that is why the economy is just moving along at this very low rate with a lot of excess capacity."

(Editing by Tim Ahmann and Neil Stempleman)

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