Mark Zandi

is chief economist at

Moody's Economy.com

The economic coast is not clear. A dizzying recent slide in stock prices has brought back that queasy feeling from when the financial system was imploding and employers were slashing jobs. It should be clear that policymakers have much more to do to secure the recovery and prevent a slide back into recession.

This time the financial turmoil emanates from Europe. It began in Greece, whose economy never emerged from recession and whose fiscal problems are the most severe. The Greek government's deficit and debt load are among the world's highest, and holders of Greek bonds are rightly nervous that the country may lack the resources or political will to repay them. Such worries have quickly extended to other hard-pressed European nations with weak economies and big fiscal problems, notably Portugal, Ireland, Italy, and Spain.

The European crisis has taken a more serious turn as banks and other financial institutions begin to choke on their sovereign-debt holdings. European banks have grown more reluctant to lend to one another at reasonable interest rates, fearing their counterparties may fail and they won't be repaid. This type of angst was the catalyst for the string of banking failures that wracked the U.S. financial system not long ago.

Even if markets avoid a repeat of that dark scenario and stabilize soon, a significant amount of damage has already been done. Europe's economy, which was barely growing even before all of this, will almost surely fall back into recession. The euro and British pound are also sure to slide much further in value. The European Central Bank (ECB) will have to keep interest rates low for longer to shore up the economy.

The United States will also feel the effects. Europe is a big market for our exports; a recession there will hurt U.S. producers. Weaker European currencies could also hurt the profits of U.S. companies with operations over there. None of this has been lost on investors, who have sparked a double-digit correction in the stock market. The previous yearlong stock rally had helped fuel recovery, emboldening wealthy households to spend more and signaling to businesses to hire and invest. A weakened stock market no longer provides an economic tailwind; if it doesn't stabilize soon, the market will become a headwind.

It's tempting to be pessimistic about how all this will turn out. There is talk that one member or more will leave or be forced out of the eurozone, or that the single-currency union will collapse entirely. But such pessimism is overdone. Policymakers finally appear to be getting ahead of events, and while they are sure to misstep again, officials seem determined to prevail. The European Union and International Monetary Fund have committed an impressive $1 trillion to help struggling European nations meet their debt commitments. This will cover most of the troubled debt coming due in the next several years. The ECB is also buying up debt at a prodigious pace. There is thus little chance of a default any time soon.

This doesn't mean there won't be defaults if Europeans don't ultimately make some hard fiscal choices. But countries seem to be doing just that. The most troubled nations have proposed fiscal austerity plans, and some are beginning to implement them despite strong public objections, as demonstrated by the riots in Greece. Next to tackle their fiscal problems will be the British, who know they must propose a disciplined fiscal plan or suffer the wrath of investors.

It is often true, moreover, that what doesn't kill you makes you stronger. The current crisis will ultimately produce a healthier, more stable Europe. In exchange for backing the debt of Europe's troubled governments, the EU, IMF, and ECB will be given more authority to monitor and even oversee these nations' fiscal policies. Greater coordination and thus a more workable eurozone will result.

While it may be stretching optimism a bit, it isn't unthinkable that Europe's debt crisis could even prompt the United States to address its own looming fiscal issues. Our problems aren't as acute as Europe's, as our economy is more dynamic and our debt load not nearly as burdensome. Given the dollar's global reserve status we also have more time to put our fiscal house in order. European nations have a few years to get it together; we have closer to a decade.

Global investors also seem willing to give the United States the benefit of the doubt. Fixed mortgage rates have never been lower, and other rates have fallen as well, because investors still believe a U.S. Treasury bond is the closest thing to a risk-free security. There is a reason for their trust: namely that Americans have risen to significant fiscal challenges in the past. Our current predicament is more serious than most we have faced, but when push comes to shove we have shown amazing political flexibility.

Still, investors won't wait very long. If we haven't improved our fiscal outlook by this time next year, we - and not the Europeans - will be in the markets' crosshairs.