One of the better analogies for understanding the Euro crisis is to look at the USA and the relationship between the states and the federal government. The USA, like Europe’s nations, is made up of a group of states that are all users of a single currency. There is no trade rebalancing between the states because there is no floating FX between the users and they all have a potential solvency constraint since they can’t print dollars (ie, they can all “run out of money”). Europe functions largely the same way (though it’s a bit more complex than that since they have national central banks, but the basic idea is the same).
Everyone knows the states in the USA have had major budget woes in recent years as revenues collapsed following the crisis. And few predictions were more vocal in the last few years than Meredith Whitney’s call for hundreds of billions in municipal defaults (she wasn’t the only one though probably the most vocal). But the crisis at the state level never panned out. Why not? The answer is simple and it gets to the crux of the difference between Europe and the USA.
The states in the USA, being part of a UNITED monetary system, have access to federal funding (and the federal government can’t “run out of money“). So, while they have balanced budget amendments they also have access to the Federal government’s bottomless money pit. This has been crucial in understanding why there was never a state solvency crisis. Highlighting this point was a recent piece by the NY Fed:
“To mitigate the loss in state and local government revenue, the federal stimulus bill provided a substantial increase in federal aid, as the chart below suggests. Nevertheless, the stimulus offset only part of the effects of declining tax revenues, and total state and local revenues still dropped. Combined with the requirement to balance their operating budgets, the revenue gap forced states and localities to make difficult choices. Between fiscal years 2009 and 2011, states alone were compelled to make up more than $430 billion in budget shortfalls in order to satisfy their balanced budget requirements. Information on local government actions is harder to obtain, but it is likely that they also had to close large gaps.”
This has had a massively positive impact on the overall economy in the USA. It’s likely that if the states had not been bolstered by the Federal government we could have had much broader solvency issues at the state level and perhaps something more closely resembling the crisis in Europe where unemployment rates are 20%+ in many countries. Here’s more detail on this from the centre on Budget and Policy Priorities (CBPP):
“Federal assistance lessened the extent to which states needed to take actions that further harmed the economy. The American Recovery and Reinvestment Act (ARRA), enacted in February 2009, included substantial assistance for states. The amount in ARRA to help states maintain current activities was about $135 billion to $140 billion over a roughly 2½-year period — or between 30 per cent and 40 per cent of projected state shortfalls for fiscal years 2009, 2010, and 2011. Most of this money was in the form of increased Medicaid funding and a “State Fiscal stabilisation Fund.” (There were also other streams of funding in the Recovery Act flowing through states to local governments or individuals, but these will not address state budget shortfalls.) This money reduced the extent of state spending cuts and state tax and fee increases.”
And a bit more:
“Although it is still too early to have a complete picture of how the funds are affecting every state’s budget, all evidence to date suggests that the money is making a substantial difference. Without the funds, the extent of budget cuts undoubtedly would be greater. A handful of concrete examples: (see link)”
Luckily, the USA is not Europe and is not becoming Europe because the USA has the political and fiscal unity that Europe woefully needs to complete their monetary union. The recent crisis has made this abundantly clear by now.
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