Heed the crisis, not the panic

Markets: There's panic in the markets, and crisis in the euro zone. The first reflects fears of global recession. That would be panic-worthy, but is still only a threat, not a reality, and policymakers should not leap to respond. The euro zone's problems, however, are real and systemic, and demand a determined policy response.

The crisis in the euro zone is that of an experimental system and is hard to resolve. It has spread to Italy, a country that is too big to fail or to bail. Italian debt now yields a bit more than Spain’s. Markets are looking to the European Central Bank to provide exceptional support, but conventional policy by the countries themselves should be the focus. Italy’s plans to reduce its fiscal deficit are too long-term and need to be accelerated. The country can drive down the yields on its bonds by convincing investors that Rome intends to remain solvent by fiscal tightening. Looking to the ECB to buy Italian bonds, as Italy’s finance minister Giulio Tremonti did this week, suggests a lack of resolve. The Spanish government has also been trying to reduce its deficit, but it too should go further and put more pressure on regional governments to improve their finances. These problems are ones of political will. If now is not the time for bold action, when is?

Market falls are of course not without risks for banks, investors and consumers, whose solvency, wealth and confidence may be hurt. But US and global policymakers should not emulate the markets' fright and rush to embark on more quantitative easing (money printing) to stimulate the world economy. True, the world is affected by Europe's woes. Unquestionably some data has been weaker and the United States’ recovery from the Great Recession is disappointingly slow. But it’s not clear that the US economy is heading back into recession. Asian growth still appears good.

The world economy may prove more resilient and less in need of QE than the markets. And the US Federal Reserve should remember that one factor deterring consumer spending is the very high price of oil and other commodities. That is itself a reflection of QE and a weak dollar, which have caused rising inflation globally, forcing China, India and many others to raise interest rates and curb their growth. Instead of more QE, the world may need some of the policy's unfortunate inflationary side effects in the markets to be expunged. That welcome process may be happening now.