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Opinion | Catherine L. Mann

Disciplined borrowing needed to fix European crisis

Catherine Mann advocates a two-tiered bond market.

Catherine Mann advocates a two-tiered bond market.

The euro crisis affects the United States through three channels: It hurts exports, increases the exchange rate of the dollar, and keeps the eyes of financial markets off our own fiscal issues.

US exports have been hurt directly by European sovereign debt and banking crises, which have tipped Italy, Spain, Greece, and others into recession. As a result, the growth of US exports to the eurozone, which accounts for 18 percent of American exports, has slowed in each of the last six quarters.

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The European crisis, meanwhile, is cascading on to other countries. China, for example, exports more to Europe than to America, and China’s slowdown can be traced in part to the euro crisis. China’s slowing, in turn, drags down global growth and further dampens US exports.

Overall, real US export growth has been cut in half, from an 8 percent annual rate before the crisis to 4 percent in the first quarter of this year. Slower export growth is one reason for our tepid recovery.

The appreciation of the dollar is the second channel through which the euro crisis affects the United States. The dollar has appreciated as much as 15 percent against the euro, as well as other currencies, as investors flee to safer US Treasury securities. While that means American tourists can enjoy cheaper lattes in Italy, it also makes US exports less competitive in global markets.

Finally, the euro crisis has kept financial markets’ eyes off the US budget. The federal deficit has been running at 8 to 10 percent of US economic output for several years now, piling up debt at a rate that will soon push the nation into the territory where financial markets punished the Europeans by refusing to buy government debt or demanding very high interest rates. We are next, if Europe gets its act together before we do.

So, what are the economic solutions to the euro crisis? By and large, economists agree that not all countries in Europe should follow a program of austerity, and bonds backed by the entire eurozone should play a role.

First, on austerity. No country that hacks spending and raises taxes will generate growth in the short-term, even if fiscal discipline is critical to long-term growth. In Europe, some countries, such as Germany, Belgium, Luxembourg, have small deficits. Countries with room to spend more on infrastructure or reduce taxes should do so. But, no eurozone agreement enforces this behavior, which would be in the best interest of Europe and the global economy.

Second, a key reason for the crisis is financial markets first assumed that with a single monetary policy, all sovereign debt (from Germany to Greece) had the same risk, and therefore should receive the same interest rates. Then, realizing a single monetary policy does not ensure uniform fiscal discipline among nations, the markets differentiated to the extreme between Greek and German debt, jacking up interest rates to unsustainable levels for Greece, while keeping them low for Germany.

A two-tiered bond market could solve this. National governments could issue bonds backed by the entire eurozone to cover reasonable deficits, say up to 3 percent of economic output. Presumably, the markets would accept lower interest rates on this debt. To finance larger deficits, governments would issue their own bonds, presumably at higher rates. This approach would allow the financial markets to discipline excessive borrowing while keeping the eurozone whole.

Catherine L. Mann is the Barbara ’54 and Richard M. Rosenberg Professor of Global Finance and director of the Rosenberg Institute of Global Finance at Brandeis University’s International Business School.
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