European leaders will meet in Brussels on Thursday and Friday in yet another attempt to assure the markets that Europe isn't going to fall apart. Yet economists in Europe and the United States agree that the solution to Europe's problems lies largely outside of diplomatic summits.
These economists said that only one institution can prevent a breakup of the eurozone: the European Central Bank. The ECB could do for Europe what the Federal Reserve did for the United States in the wake of the 2008 financial crisis: Pump more money into the financial system and buy troubled assets -- in this case sovereign debt instead of mortgage-backed securities. At a minimum, economists said, the ECB needs to issue so-called euro bonds, sovereign debt backed by the ECB, or promise to lend an unlimited amount to troubled European countries such as Spain and Italy.
In spite of European pleas for monetary assistance, the continent shouldn't count on outside help. U.S. Treasury Secretary Timothy Geithner said on Tuesday that he does not expect the Federal Reserve to step in. A top Chinese official also recently said that China is not planning to use its reserves to help bail out Europe.
"The bulk of the money will have to come from the Europeans themselves, because Europe has the means of solving this problem," said Jurgen Odenius, chief economist at Prudential Fixed Income. "Why should it expect the rest of the world to deliver the answer?"
The ECB has hinted that it may lend more, but the bank wants debt-ridden European countries to cut back first and accept more budget oversight. Mario Draghi, the ECB's new president, suggested on December 1 that the ECB may buy government bonds more aggressively if the eurozone gets "a commonly-shared fiscal compact right."
By withholding funds from troubled European countries in order to force austerity measures, the bank is playing "Russian roulette," said Barry Eichengreen, an international economist at the University of California at Berkeley.
Still, so far, governments appear to be playing along. Italy's government, led by new Prime Minister Mario Monti, recently pushed forward austerity measures, which include raising the retirement age. Spain's prime minister elect, Mariano Rajoy, also has been advocating for budget cuts. But Italy and Spain still need to reform their labor markets, according to some economists.
The ECB has expressed concern about printing money to bail out troubled European countries because a larger money supply would cause inflation in the future, and they are not allowed by law to buy sovereign debt directly from governments to bail them out.
But there is a way around this technicality, a number of economists said. The ECB could lend to the International Monetary Fund or to the European Financial Stability Facility, Europe's bailout fund. Neither the IMF nor the EFSF have enough money to be able to bail out Italy and Spain, but they would if the ECB lends to them. Mark A. Roscam Abbing, head of the public finance department at the CPB Netherlands Bureau for Economic Policy Analysis, said that 1.5 trillion euros, about $2 trillion, would be enough to calm the markets.
Some economists said that despite the ECB's vague hints at further assistance, the central bank will come around because it recognizes that the future of the euro is at stake. Anton Brender, chief economist at Dexia, a large bank in Belgium, said that Draghi "has good reasons to try to avoid a breakup of the euro." He and everyone else at the ECB would lose their jobs if the eurozone broke up, he said.
German Chancellor Angela Merkel, arguably the most powerful politician in Europe, has ruled out one possible option, so-called haircuts, when investors are forced to take losses on sovereign bonds. Merkel said on Monday that she wants to rule out doing more of these. In October, European leaders forced private bond-holders to take a 50 percent haircut on Greek sovereign debt.
Oxford economist John Muellbauer calls this Merkel's "naive view of the markets."
Even if the ECB staves off the immediate crisis by buying more sovereign debt, it would not solve the continent's underlying problems, economists said. Ultimately, the European economy needs to grow, and until that happens, Germany and its northern neighbors may be forced to transfer some wealth to southern Europe.
"The underlying contradiction still has to do with a poor and slower-growing south versus a rich and faster-growing north," said UC Berkeley economist Robert Reich. "It just means continuous subsidies from north to south because the north again gets the benefits of a common currency in terms of exports. The south really can't export its way to growth because the euro is simply overvalued."
IHS Global Insight projects that the European economy will shrink 0.5 to 0.75 percent in 2012. Austerity measures could shrink the economy further and increase countries' deficits, said Lewis Spellman, finance professor at the University of Texas at Austin's business school.
The structural economic reforms that Italy eventually will be forced to implement may not jumpstart economic growth for another decade, Abbing said, drawing from his country's own history. "The Dutch economy was in terrible shape in the 1980s," he said. "It took some 10 years before we bore the fruit of those reforms."