Not Just Their Problem: Europe's Debt Crisis and U.S. Fiscal Policy

This project was made possible in part through a generous grant by Mr. Gene Gabbard.

The Full Paper can be downloaded as a PDF Here.


When Americans talk about Europe’s debt crisis, they often focus on object lessons for the United States. Are Greece or Portugal early warnings about over-spending and fiscal irresponsibility in this country? Will the United States be next?

The comparisons are hard to resist: unsustainable increases in government debt on both sides of the Atlantic, aging populations and political paralysis. But the economic and political contrasts are at least as important, and the policy lessons can be difficult to discern and easy to misconstrue.

Two things are certain: Europe is facing dire challenges, and in a global economy what happens there will have an impact here. That is why economic forecasts for the United States are now routinely coupled with warnings about “headwinds” from Europe.

This paper briefly describes the European debt crises and how they are affecting European economies. It then outlines the spillover dangers for the U.S. economy and in turn the U.S. fiscal outlook. Next, the similarities and differences between the U.S. and European fiscal challenges are discussed. The paper concludes with fiscal policy lessons the U.S. can take away from the evolving European experience.

The Highlights:

  • The biggest fiscal danger from Europe comes through the interconnectedness of our economies. Europe could induce a slowdown in the United States, which would mean higher deficits, and neither our economy nor the federal budget is in strong enough shape to easily handle new short-term shocks.
  • A Europe-wide financial meltdown isn’t the only risk. Exports are now a major source of American economic growth. A prolonged European economic slump even without defaults or exits from the Euro could hurt longer-term U.S. growth and aggravate what is already an unsustainable trend in the federal debt.
  • The United States is not Greece, Portugal or Spain. U.S. government debt has soared since 2008 and -- as a share of GDP across all levels of government -- has risen higher than that of the euro countries overall. But U.S. interest rates remain very low -- a signal that we are far from the public credit crisis that afflicts some European countries.
  • The United States is more comparable to wealthy “core’’ European countries such as Germany and France. In sharp contrast to Greece or Portugal, neither the United States nor those healthier European economies face any serious bond-market rebellion yet. Despite undisputed long-term fiscal problems, they can all still finance their needs at some of the lowest interest rates in postwar history.
  • Europe’s debt crisis isn’t only -- or even mainly -- the result of runaway government spending. Ireland and Spain had budget surpluses and very low debt as recently as 2007. Italy has had high debt, but its current deficits are relatively low and declining. Their problems stemmed primarily from rescuing private banks, which were flooded with money from “core” eurozone countries and then blind-sided by the Great Recession.
  • Political leaders in Washington can’t do much about the European economy. But they can boost worldwide investor confidence by taking actions regarding our own fiscal situation that would demonstrate that we are not headed down the same path as the most problematic European countries.
  • The United States can learn from the European experience that excessive budget austerity during a tenuous economic recovery can make things worse. In the long term, however, persistently high deficits will undermine confidence, drive up interest rates and choke off growth in the nation’s productive capacity. We must find the delicate balance between: (i) adequately supporting the demand side of the economy in the near term, and (ii) making credible commitments to policies that will reduce budget deficits and increase supply-side growth over the longer term.