November 29th, 2011
Econintersect: CEPR (Center for Economic and Policy Research) Co-Directors Dean Baker and Mark Weisbrot called on the Federal Reserve to stabilize European bond markets by buying Italian and Spanish bonds – and other sovereign bonds as necessary – thereby lowering interest rates on these bonds. The two, in a press release dated November 28 (Monday), issued a statement which is reproduced after the continuation break.
For Immediate Release: November 28, 2011
Contact: Dan Beeton, 202-239-1460
Washington, D.C.- Center for Economic and Policy Research Co-Directors Dean Baker and Mark Weisbrot today called on the Federal Reserve to stabilize European bond markets by buying Italian and Spanish bonds – and other sovereign bonds as necessary – thereby lowering interest rates on these bonds. They issued the following statement:
"The risk of a financial meltdown in Europe is significant and growing each day. The financial fallout could be bigger than that following the collapse of Lehman Brothers in 2008, and could easily push the U.S. economy into recession. The European authorities are moving much too slowly to contain this risk. The European Central Bank (ECB), especially, is not fulfilling its function as a central bank to act as a lender of last resort in a crisis situation.
"The ECB needs to intervene in order to stop the yields on Italian and Spanish bonds from rising to the point where they are no longer able to borrow from private markets, as happened to Greece, Portugal, and Ireland. But it has refused to do so, and last week German Chancellor Angela Merkel directly rejected the idea of Eurobonds, on the grounds that it would reduce pressure on the weaker economies to cut their budgets.
"The failure of the ECB to act creates the need for the Federal Reserve to act as part of its mandate to promote full employment in the United States. The Fed's intervention will put an end to the vicious cycle that has sent Italian and Spanish bond yields soaring, which in turn has increased their borrowing costs and made financial markets increasingly skeptical that their debts will be paid.
"The current policies of austerity as a solution to the crisis have only exacerbated it, as the eurozone's projected growth for next year has been lowered to 0.5 percent and further budget cuts increase the risk of a regional recession. This further weakens the eurozone's undercapitalized banking system, increases capital flight and increases the risk of financial meltdown.
"The Fed's more than $2 trillion of quantitative easing in the United States has succeeded in lowering long-term interest rates here at no cost to the taxpayer, and has had no measurable effect on inflation. The Fed can embark on a similar program of buying sovereign European bonds, which would also be costless to U.S. taxpayers and merely result in the accumulation by the Fed of foreign reserve holdings. It would be much smaller in size than the domestic quantitative easing that the Fed has carried out to date, and even less likely to impact inflation. On a per dollar basis, it is difficult to envision anything the Fed could do that would have a larger impact on growth and employment in the United States.
"It is possible that the threat of the Fed's action would move the ECB to act on its own. But in any case, the stakes are too high for the U.S. economy for the Fed to sit on the sidelines. The rest of the world, much of which is already feeling the effects of the instability in the eurozone, would also be likely to support and appreciate Fed action."
Baker, writing in Al Jezeera, says the U.S. experienced an effect due to China buying large amounts of long-term U.S. debt in 2004-2006 with the effect that the long bond stayed flat and even declined slightly as Greenspan raised short-term rates from 1% to 5.25%. The effect was that the U.S. economy stayed strong during that time period in spite of significant Fed tightening.
Baker and Weisbrot propose that the U.S. should now do for Europe what the China did for the U.S.
Editor’s comment: Of course, within a year of the two-year Chinese action that offset the effects of Fed tightening, the U.S. and the world entered into the 2007-2009 bear market and the financial crisis that peaked in 2008-2009. What will be the follow-on if the U.S. takes a similar action with regard to Europe?
Hat tip to Roger Erickson