The United States faces variable headwinds slowing its recovery, but clarity out of Europe would best position the country toward smoother sailing ahead, says Barry Eichengreen, a University of California, Berkeley economist.
European policymakers are mulling ways to firewall and dowse the debt crisis that is spreading from Greece to Spain, where borrowing costs are soaring in government debt auctions on concerns that Madrid is finding financing itself increasingly difficult.
Fears that Greece will exit despite recent bailouts and pressure Spain to follow suit have cooled the broader European economy and have dampened sentiment in the U.S. as well.
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"I think some clarity in terms of what is going to happen in Europe will probably be the single most important thing that would solidify recovery in here in the United States," Eichengreen tells Newsmax.TV in an exclusive interview.
Meanwhile, the Federal Reserve can always prime the economy with monetary policy tools such as quantitative easing, which sees the U.S. central bank buying assets like bonds from banks, injecting the economy full of liquidity to spur recovery.
However, more action from Congress on narrowing deficits would lead to more lasting improvements, though that's not likely in an election year, Eichengreen says.
"I'm of the view that the Fed needs to do more and if the recovery continues to wobble as it has, that the Fed will do more. I think there is a role for supportive fiscal policy. We have to deal with the possibility of a fiscal cliff at the end of the year. Massive tax increases would not be a good thing against the backdrop of a weak economy."
At the end of the year, the Bush-era tax cuts and other tax holidays expire at the same time automatic cuts to government spending kick in, a combination known as a fiscal cliff that could siphon hundreds of billions of dollars out of the economy and possibly throw the country right back into recession.
Federal Reserve stimulus measures won't stop the country from going over the edge of the fiscal cliff — only Congress can prevent that.
Still, what little support the Fed can provide will be welcome.
"The Fed has fired a lot of bullets and its interventions are kind of reaching the point of diminishing returns, but diminishing is not the same as zero," Eichengreen says.
"The central bank is really the only adult in the room at this point. The Fed has become the policymaker of last resort because Congress is gridlocked, and we're in an election year. So it's undesirable that the weight of the world is being placed on the Fed."
Since the downturn, the Fed has pumped $2.3 trillion into the economy via two rounds of quantitative easing, known widely as QE1 and QE2.
Supporters say such measures steered the country away from devastating deflationary decline by pushing long-term interest rates low while fostering conditions for hiring in the process.
Critics say the policy is basically printing money out of thin air, plants the seeds for inflation down the road and hasn't done much to spur recovery anyway.
A little inflation isn't a bad thing, Eichengreen says, adding fears of hyperinflation are overblown.
"For some people hyperinflation is right around the corner. I think that corner is very, very far away. I think the Fed has some considerable amount of time to shrink its balance sheet and reverse out all the operations that it has undertaken in recent years," Eichengreen says.
"Moreover, there's a big difference between the hyperinflation, which would be a terrible thing, and modest inflation of 3-4 percent, which is exactly what the economy needs under present circumstances."
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