European Central Bank’s Inaction Could be Costly to U.S. and World Economy
Contact: Dan Beeton, 202-239-1460
Washington, DC– Center for Economic and Policy Research (CEPR) Co-Directors Dean Baker and Mark Weisbrot issued the following statement today, calling for action by the U.S. Federal Reserve to contain the eurozone crisis. Weisbrot just returned from Spain, where he observed the impact of the crisis firsthand.
The statement reads:
“The financial crisis in the eurozone, now centered on Spain, is contributing to the slowdown in the U.S. economy and opens the possibility of a worse financial meltdown, of the type that followed the collapse of Lehman Brothers in 2008. This could tip the U.S. economy into recession.
“The European Central Bank (ECB) could put an end to the acute crisis by intervening in the Spanish bond market, as it has done in the past year, thereby stopping financial markets from driving these bond yields to levels at which Spain’s debt is seen as unsustainable. But it has so far refused to do so.
“The Financial Times reported yesterday that ‘A widespread view within the [ECB’s governing] council’ is that prior interventions ‘simply reduced the incentive for governments to act;’ and that ‘the ECB also has to judge whether to take pre-emptive steps to prevent the situation spinning out of control at the risk of lowering the pressure for political reform or wait to see how events pan out before responding.’
“The ECB’s refusal to act, for political reasons, is reckless and inexcusable. Since the eurozone crisis is affecting unemployment in the United States, and threatens to raise it further, it is within the Fed’s mandate to act in this situation.
“Past interventions by the ECB indicate that the amount of intervention would be relatively little. According to press reports, the Fed is currently considering an additional $700 billion of quantitative easing in the United States; the amount necessary for intervention in the Spanish bond market would be a small fraction of this, and possibly have more impact on the U.S. economy. Past actions indicate that private investors would move quickly to buy Spanish bonds on the heels of a central bank intervention. Furthermore, the intervention would come at no cost to the U.S. taxpayer, and the Fed would accumulate foreign assets in its reserve holdings.
“U.S. Treasury rates fell to all-time record lows last week, as fear seized financial markets worldwide. More than $100 billion left Spain in the first quarter of this year – nearly 10 percent of Spain’s GDP – and it is likely that capital flight accelerated in April and May. This capital flight worsens the situation of the Spanish banks, as does the fall in the price of Spanish bonds, which are held mostly in Spain. All of this makes the banking and financial crisis worse. The eurozone recession is deepening, and the financial crisis there is affecting many parts of the world economy.
“It is possible that action by the Fed would also cause the ECB to intervene. But in any case, it is within the Fed’s mandate and ability to contain this crisis. It should act quickly before there is further damage to the U.S. economy.
“Other central banks with large reserve holdings may also want to consider intervening as well, if the Fed does not act, or in conjunction with the Fed if it does.”