I had a heated discussion about our new baseline scenario yesterday with some angry European politicians. Specifically, the most agitated were from the eurozone and they find our assessment of the risks and likely futures in that region to be unacceptable. In their view, this is an American problem and that is where the impact will be felt.
While we can surely agree that regulatory failings (and more) in the US are at the epicenter of the crisis, we are facing a global problem precisely because other countries’ banks are involved either directly (because they bought a lot of claims on assets that went bad; see your domestic regulators for details on how that happened) or indirectly (because they finance trade with the US/Europe, and this is now slowly markedly). And we should no longer think of this as a supply side problem in the credit market; increasingly, consumers and firms around the world want to spend (and borrow) less.
And here’s the point about Europe – perhaps the reason there is so much anger and even some denial. European governments have a lot of debt – in the case of some weaker eurozone countries, this stands at over 90% of GDP. Fiscal policy did not prepare for a financial sector problem of the current magnitude and the way in which bank recapitalization was handled recently has only exacerbated the underlying solvency issues. As a result, there is very little room for a meaningful fiscal stimulus; if governments attempt even more, there will be issues of confidence. Quite probably there will be pressure for austerity even at current debt levels.
The Europeans really need to get organized to provide more support to weaker EU countries and the weakest eurozone members. Try to deliver this message at every opportunity. If you get shouted down, keep at it.