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Robert Herren, NDSU Extension Service, Published April 16 2012

Spotlight on Economics: Macroeconomic outlook - European sovereign debt crisis

Recently, students in my macroeconomics classes and participants in my macroeconomic outlook presentations at Extension Service-sponsored conferences have asked how the European sovereign debt crisis affects the economies of North Dakota and the U.S.

Although the direct effect on North Dakota is minimal because direct trade between Europe and North Dakota is relatively small, indirect effects are larger because commodity and financial markets are globally integrated. Many economists believe that a potential recession in Europe may weaken economic growth in the U.S substantially.

Several countries with sovereign debt problems are members of the 17-nation Eurozone, which complicates their economic recovery. Many economists have been skeptical about the Eurozone's long-term viability since its creation in the 1990s. The current situation illustrates underlying problems for nations in the Eurozone.

Nations in a monetary union lose the ability to use some macroeconomic instruments to deal with specific domestic problems. In the Eurozone, each nation yields control of monetary policy to the European Central Bank. Each nation also relinquishes power to change exchange rates relative to other nations in the Eurozone. Nations with different economic problems previously could have used different monetary policies.

A nation that was overheating would follow a contractionary monetary policy that would raise real interest rates and appreciate its currency. A nation that had a stagnant economy would adopt an expansionary monetary policy that would reduce real interest rates and depreciate its currency. However, in a monetary union, two nations cannot have different monetary policies because monetary policy is the same for all countries within the union.

Monetary unions can deal with disparate economic situations of different regions through the mobility of the labor force. Workers can move from areas of high unemployment to areas of low unemployment. For example, western North Dakota is experiencing such an influx of workers from other parts of the U.S., which is a monetary union. In addition, monetary unions can use centralized fiscal policies to deal with areas of high unemployment.

Critics argue that the Eurozone is not able to deal with disparate economic conditions because Europe has low labor mobility, even within countries. Fiscal transfers (spending tax revenues from one country in another country) from better-performing regions to worse-performing regions will require substantial political changes in Europe. Therefore, a single currency may lead to some regions of Europe being depressed for substantial periods of time, while other regions are booming.

The impact of a membership in the Eurozone, combined with externally imposed fiscal austerity and the lack of willingness to engage in fundamental institutional reform, most likely will result in continued slow economic growth in countries such as Greece.

The sovereign debt problems within the Eurozone will continue to affect global financial markets adversely in 2012 and beyond.

Robert Herren is an economics professor in the NDSU Department of Agribusiness and Applied Economics.