Euro at Risk as North-South Political Rift Threatens Financial Stability
A new report by the Federal Reserve Bank of New York examines the implications of the European Union (EU) fiscal problems for the US economy. The article says that the rise in sovereign debt levels and the weakened economies of the eurozone countries threaten to undermine the US’s ability to manage the risks posed by its financial institutions.
According to the article, the US government should be prepared to intervene if needed to ensure financial stability and avoid a worsening of the situation in Europe. Some observers believe that the European debt crisis may signal the beginning of the end of the Eurozone. According to one expert, it is quite possible that the crisis in the Eurozone will become a permanent feature of financial markets.
The danger posed by the debt crisis is that the problems may spread throughout the whole of the European banking system and result in a potential systemic failure. As a result, the risk of a large scale insolvency in the Eurozone would grow. In this situation, the US is likely to become more inclined to intervene and prevent the domino effect that the insolvency of Eurozone banks could cause.
The impact of the dollar crisis on the European economy has been identified in the report by the New York Fed. The paper says that the US dollar has had a strong grip on the global currency market for more than two decades, but the relatively weaker position of the US dollar is causing problems for financial markets globally. This is because the US economic performance has been weak, the Eurozone countries are in deep crisis and the dollar has enjoyed very low rates against other major currencies over the past year.
In the US, the financial system is vulnerable to capital flight as a result of the depreciation of the dollar. However, the paper points out that, because of the less robust financial institutions in the United States, there is the potential for substantial capital losses if investors consider that the weaker US dollar will strengthen over time.
According to the report, the biggest threat posed by the Eurozone problem is a weakening of the US economic recovery, thereby making it more difficult for the US government to control fiscal policy and reduce the deficits and debt levels. This will increase the pressure on the US central bank to print more money to offset the weakening US economy.
The Federal Reserve paper further points out that the US government has a limited ability to influence the general state of the Eurozone, as the EU is a leading developed economy. However, it can use monetary policy to offset any risk posed by the Eurozone crisis. According to the paper, there is a risk that the US will end up in a scenario whereby “the ECB decides that the US economy is improving sufficiently to justify even higher ECB inflation targets”.
One of the recommendations of the paper is that the US government should adopt a monetary policy that will reduce the risks posed by the Eurozone. If this does not happen, then the government should take steps to increase the role of the private sector in stabilising the economy.
According to the New York Fed paper, any reduction in the overall size of the Eurozone, even if it means tightening fiscal policy to the disadvantage of the US, is likely to reduce inflation in the US. So far, the US has only been able to offset the impact of the decline in prices caused by the deflationary impact of the Chinese economic slowdown.
Another recommendation of the paper is that the US government should take a closer look at the size of the Eurozone, especially in terms of the size of the European Monetary Union (EMU). It is also necessary to explore the possibility of a common central bank for the Eurozone countries.
According to the paper, the European Central Bank (ECB) has traditionally been too close to the single currency group and that this has led to negative interest rates and an expansion of the Eurozone fiscal policy. The paper states that the ECB should revise its interest rate and macroeconomic policy to be more neutral and should examine the possibility of a common Eurozone bank.
The economic crisis in the Eurozone poses a risk to the stability of the world economy, which is why the US is likely to take a stronger role in influencing the issue. according to the New York Fed paper.