In a speech today in London, St. Louis Federal Reserve President James Bullard told the audience that “among many factors affecting the U.S. in the medium term, the ongoing European crisis is the most pressing one from the U.S. point of view.” He says further:
The crisis is contributing to recession, adding a dragging factor on U.S. and Asian performance. There is a financial sector dimension which periodically threatens to expand into a more generalized financial crisis. It has been difficult for many in the U.S. to envision how the situation will develop going forward.
One way the situation could develop is that one or more countries could decide to leave the Eurozone, which Bullard calls a “club”, membership in which depends on the incentives available. The incentives to remain are different for Greece and, say, Germany, and any policy decisions “can no longer assume that the political processes will back the [monetary union] in all circumstances.”
Bullard then argues that a “grand bargain” on the table that could work. He called it a “Hamilton moment,” similar to the moment in US history when the federal government assumed the debts of the states in exchange for certain federal rights. For Europe, Bullard suggests that a stronger European government could assume sovereign debt “ in exchange for balanced-budget amendments or similar binding restrictions on future borrowing and a ceding of greater power to the European-wide government. Powers of the European Parliament, in particular taxing authority, might be increased.”
Bullard also doubts whether fiscal expansion — for example more quantitative easing — can achieve the desired result of lower deficits. That solution requires a “tax-financed increase in expenditure, not a deficit-financed one.”
Such an approach is likely to be just as popular in Europe as it is in the US — which is to say, not at all popular. Bullard concedes that his “grand bargain” scheme also has a low probability of being adopted. At least he’s a realist on that score.
A full copy of Bullard’s remarks are available here.