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Tuesday, October 4, 2011

The Future of the Eurozone and U.S. Interests

Raymond J. Ahearn, Coordinator
Specialist in International Trade and Finance

James K. Jackson
Specialist in International Trade and Finance

Rebecca M. Nelson
Analyst in International Trade and Finance

Martin A. Weiss
Specialist in International Trade and Finance

Seventeen of the European Union’s 27 member states share an economic and monetary union (EMU) with the euro as a single currency. Based on a gross domestic product (GDP) and global trade and investment shares comparable to those of the United States, these countries (collectively referred to as the Eurozone) are a major player in the world economy and can affect U.S. economic and political interests in significant ways. Given its economic and political heft, the evolution and future direction of the Eurozone is of major interest to Congress, particularly committees with oversight responsibilities for U.S. international economic and foreign policies.

Uncertainty about the future of the Eurozone began in early 2010 as a result of the onset of a sovereign debt crisis in Greece. Subsequently, concerns spread that Ireland, Portugal, Spain, and Italy also lacked sustainable fiscal positions. Fearing possible defaults, markets began demanding substantially higher interest rates for their bonds. The debt problems of these countries, while different, now constitute a serious risk to the European banking system, the viability of the euro, and the European integration process. Moreover, the debt crisis has intensified as the Eurozone economy stagnated during the second quarter of 2011, creating problems not only for Europe, but also for the world economy.

One important cause of the crisis stems from flaws in the architecture of the currency union, including the fact that the EMU provides for a common central bank (the European Central Bank or ECB), and thus a common monetary policy, but leaves fiscal policy up to the member countries. Weak enforcement of fiscal discipline, over time, facilitated rising public debts. Locked into the euro, members cannot inflate their way out of large public debt or devalue their currency to make their exports more competitive.

In response, European leaders and institutions have combined measures to ease the debt crisis with financial assistance packages for Greece, Ireland, and Portugal. The most highly indebted Eurozone members have been forced to cut government spending and programs and to raise taxes to improve their fiscal positions. A financial assistance facility, the European Financial Stabilization Facility, has been created to help stabilize the crisis. The ECB has made large purchases of these countries’ public debt in order to calm markets. But many in Europe are now calling for more basic solutions, such as the issuance of Eurobonds, along with other institutional reforms that could provide a stronger fiscal foundation to the monetary union.

The reforms, if implemented, could strengthen the foundation of the Eurozone and bolster confidence in the euro. At the same time, a number of factors could weaken or perhaps even undermine the sustainability of the Eurozone. Public support in fiscally sound Eurozone countries, such as Germany, Finland, and the Netherlands, for resource transfers to highly indebted countries is wavering. If the Eurozone survives largely in its current form or strengthens, the impact on U.S. interests is likely to be minimal. However, if Greece or any other Eurozone member were to default on its debt, it could lead to another wave of credit freeze-ups and instability in the European banking sector that weakens a struggling U.S. economy. Longer term, if the Eurozone were to break up in a way that undermines the functioning of Europe’s single market or resurrects national divisions, the impact on U.S. economic and political interests could be deeper and more damaging.

Date of Report: September 16, 2011
Number of Pages:
Order Number: R41
Price: $29.95

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