In 2008, we learned how very interconnected the world economy has become. A bankruptcy at Lehman, a relatively small US investment bank, shook the world financial system. It also plunged the world economy into its worst postwar recession up ’til then.

This interconnectedness is why our economic policymakers would be well advised to pay careful attention to the economic troubles brewing beyond our shores. In much the same way that the 2008 bankruptcy of one of our banks spelled trouble for the rest of the world economy, so too could a debt crisis in Europe or in the emerging-market economies damage our already-troubled economy.

There is reason to be particularly concerned about another round of the eurozone sovereign-debt crisis. Unlike in 2010, when the eurozone debt crisis was centered on Greece, this time around it’s likely to be centered on Italy, whose economy is some 10 times the size of Greece’s. If in 2010 the Greek debt crisis shook US financial markets, how much more so would an Italian debt crisis do so today.

Unfortunately, Italy appears to be all too vulnerable to another debt crisis. In the wake of the pandemic, its budget deficit ballooned and its public debt skyrocketed to more than 150% the size of its economy — its highest level on record. Stuck within a euro straitjacket that precludes it from using currency depreciation to promote its exports, there is little prospect an economically sclerotic Italy can grow its way out from under its public-debt mountain.

Up until now, the European Central Bank has kept Italy afloat with its policy of low interest rates and by buying massive quantities of Italian government bonds. With European inflation having reached a record 8.5% and the euro sinking like a stone, however, the ECB is having to cease its bond-buying activities and begin raising interest rates to get inflation back under control.

All too aware of Italy’s economic vulnerability, the ECB is contemplating the introduction of a new lending facility to allow the Italian government to finance its large gross borrowing needs at reasonably low interest rates. But such efforts are all too likely to be hampered by strong German political opposition and by Italian parliamentary elections early next year, in which anti-euro parties are likely to perform well.   

Perhaps of more immediate concern than a potential European debt crisis is the prospect of an early emerging-market debt crisis. Never before have the emerging-market economies been as indebted as they are today. Seldom before have their economies been hit as hard as they are today by the ongoing COVID pandemic and the surge in oil and food prices following Russia’s invasion of Ukraine.

Adding to the emerging markets’ woes is the Federal Reserve’s recent shift to a hawkish monetary-policy stance. As has happened many times before, higher US interest rates are already causing capital to be repatriated from the emerging markets back to the United States at an increased pace. It’s prompting the World Bank to repeat its warnings that it’s only a matter of time before we see a wave of emerging-market debt defaults.

Sri Lanka, Argentina, Venezuela, Zambia and others have already defaulted, along with a number of Chinese property-development firms. Many more countries are likely to follow. Taken together, these defaults can have a systemic effect, especially as we’ll face credit problems in our own highly leveraged debt market and in the cryptocurrency debt market.

There’d never be a good time for us to face a European or emerging-market debt crisis. Now, though, would seem to be a particularly inopportune time. With the US economy already showing clear signs of slowing and with the stock market just having closed an abysmal first half-year, the last thing we need is another external economic shock in the form of a debt crisis.

In setting monetary policy in today’s international economic context, the Federal Reserve might want to pay close attention to how its actions could affect economies abroad. It might wish to do so not least because of the potential for economic developments abroad to cripple both our financial markets and our economy.

Desmond Lachman is a senior fellow at the American Enterprise Institute. He was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.