Peterson Institute for International Economics Update Newsletter
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PIIE Update Newsletter
January 11, 2012

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  Policy Brief 12-1
The Coming Resolution of the European Crisis

C. Fred Bergsten and Jacob Funk Kirkegaard
  The economic and financial problems in the euro area are clearly serious and plentiful. An increasing number of commentators and economists have begun to question whether the euro can survive. There are only two alternatives. Europe can jettison the monetary union or it can adopt a complementary economic union. Every policymaker in Europe knows that the collapse of the euro would be a political and economic disaster for all and thus totally unacceptable. Europe's overriding political imperative to preserve the integration project will surely drive its leaders to ultimately secure the euro and restore the economic health of the continent.

The key is to observe what Europe does rather than what it says. At each critical stage of the crisis, both Germany and the European Central Bank have demonstrated they will pay whatever is necessary to preserve the euro area and avoid defaults (except possibly Greece). But neither can say they will provide unlimited bailouts because this would alleviate the pressure on the debtor countries to reform and weaken the bargaining position of each creditor group (northern European governments, ECB, private lenders, IMF) vis-à-vis the others as they allocate the costs of the bailouts. Europe's key political actors in Berlin, Frankfurt, Paris, Rome, Athens, and elsewhere will thus quite rationally exhaust all alternative options in searching for the best possible deal before at the last minute coming to an agreement. For all this turmoil, however, Europe is well on its way to completing a true economic and monetary union, and will emerge from the crisis much stronger as a result.

>> Read full policy brief [pdf]

  Working Paper 12-1
Fiscal Federalism: US History for Architects of Europe's Fiscal Union

C. Randall Henning and Martin Kessler
  European debates over reform of the fiscal governance of the euro area frequently reference fiscal federalism in the United States. The "fiscal compact" agreed by the European Council during 2011 provided for the introduction of, among other things, constitutional rules or framework laws known as "debt brakes" in the member states of the euro area. In light of the compact and proposals for deeper fiscal union, Henning and Kessler review US fiscal federalism from Alexander Hamilton to the present. They note that within the US system the states are "sovereign": The federal government does not mandate balanced budgets nor, since the 1840s, does it bail out states in fiscal trouble. States adopted balanced budget rules of varying strength during the nineteenth century and these rules limit debt accumulation. Before introducing debt brakes for euro area member states, however, Europeans should consider three important caveats. First, debt brakes are likely to be more durable and effective when "owned" locally rather than mandated centrally. Second, maintaining a capacity for countercyclical macroeconomic stabilization is essential. Balanced budget rules have been viable in the US states because the federal government has a broad set of fiscal powers, including countercyclical fiscal action. Finally, because debt brakes threaten to collide with bank rescues, the euro area should unify bank regulation and create a common fiscal pool for restructuring the banking system.

>> Read full working paper [pdf]

How to Rebuild Russia

Anders Åslund
  Anders Åslund Russia needs to be rebuilt. Ample material is available: talented human capital, lots of cash, and plenty of raw materials. But how should it be done? Russia's two biggest problems—corruption and authoritarianism—are crippling the country. Therefore, the main goal of both anticorruption endeavors and democratization is to break the power of the corrupt elite. First, Russia is not likely to become democratic and be in a position to control corruption until it abandons its current Constitution that gives too much power to the president. Presidents who serve too long have too much discretionary power and are not sufficiently transparent. Second, any true democracy needs free media and transparency. Russia has a healthy and vibrant Internet media and many professional journalists, but the main media are far from free or independent. Third, Russia should adopt a law that would provide maximum public access to government information. This would go a long way toward improving transparency in government affairs. And finally, Russia should abolish the secret police (the FSB, successor of the KGB). Nobody will take law enforcement in Russia seriously, argues Åslund, until it goes after corrupt public officials, starting at the top.

>> Read full op-ed

Peterson Perspectives Interviews

audio  Does China Seek a Global Role for Its Currency?
Morris Goldstein discusses the China-Japan currency pact signed in December—and why Beijing faces obstacles in its bid to elevate the global role of the yuan.

audio  Ratcheting Up Economic Pressure on Iran
Jeffrey J. Schott says a new law calling for sanctions on Iran's central bank and new European curbs on oil purchases are raising the stakes in the West's confrontation with Tehran.

audio  North Korea's Uncertain Transition: Time for a Conciliatory Gesture?
Marcus Noland discusses the downside risks after the death of Kim Jong-il and suggests that a possible agreement to increase food aid would be appropriate.

audio  New Tensions with China on Trade
Jeffrey J. Schott says China is sending a message of displeasure on commercial trade issues that is as much political as it is trade-related.

audio  Why Do Markets Disdain Euro Summit Accords?
Nicolas Véron says the markets doubt the strength of Europe's economic prospects, its banking system, its fiscal discipline accords, and its bailout mechanisms.

audio  Outlook in Egypt: Shariah, Populism, or Reform?
Mohsin S. Khan assesses the economic implications of the recent parliamentary election victory scored by the Islamic parties in Egypt.

Recent Blog Posts

RealTime Economic Issues Watch   China Economic Watch    North Korea:  Witness to Transformation
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Russia: Revolution or Evolution?

Thinking About the Euro in 2012

Europe Must Change Course on Banks

Dissecting Durban: A Fighting Chance for Progress on Climate Change

A Euro Breakup: The Problem of Euro Assets
  Beware False Prophets of Rebalancing

Why Soccer Is a Lot Like the Stock Market In China

The Politics of Declining Land Revenues

The World in 2012 – China Predictions

RQFII to the Rescue?
  A Skeptical Voice on Food Aid

Money (That's What I Want)

Food Aid Follies

Slave to the Blog: Landmines, gossip, and the ANC Youth League

The Employee Rights Act on North Korea

PIIE Noted in the News and on the Web

Business News Network
Can EU Find Way to Show Markets Debt Crisis Is Under Control?
Jacob Kirkegaard discusses the recent French bond auction.

Council on Foreign Relations
Five Economic Trends to Watch in 2012
Jacob Funk Kirkegaard says, that with Europe's ineffective political response to the euro area crisis, a new trend will emerge in the financial markets, with investor greed surpassing market fears.

Wall Street Journal China Real Time Report
Economists React: China-Japan Currency Pact
Morris Goldstein explains why the new currency accord between China and Japan will not challenge the US dollar's status as the dominant global currency.

Recession: Where the Local Is the Global
Simon Johnson explains how a recession in the euro area would be global in nature.

The Economist
Nicholas Lardy Predicts an Economic Slowdown in China
Nicholas R. Lardy delivers his predictions for China in 2012 at the Economist's World in 2012 Festival. His session included Alice Lyman Miller, Hoover Institution at Stanford University; James Mulvenon, Center for Intelligence Research and Analysis; and Carl Walter, coauthor of Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise. The discussion was moderated by Tom Easton, US finance editor for the Economist.

Preview of Our Next Issue

Policy Brief
Another Shot at Protection by Stealth: Using the Tax Law to Penalize Foreign Insurance Companies
Gary Clyde Hufbauer

Three Evolutionary Proposals for Reform of the International Monetary System [pdf]
Edwin M. Truman

China and India: Right Policy, Wrong Place
Arvind Subramanian

Policy Brief
Japan Post: Retreat or Advance?
Gary Clyde Hufbauer and Julia Muir

Working Paper
Financial Reform after the Crisis: An Early Assessment
Nicolas Véron

In This Issue

Featured Book
Flexible Exchange Rates for a Stable World Economy Flexible Exchange Rates for a Stable World Economy

Joseph E. Gagnon
Marc Hinterschweiger

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