The epicenter for concern in Europe has shifted from Greece to Italy, with interest rates on Italian bonds rising past 7% today.  The rise comes despite the European Central Bank (ECB) buying up bonds over the last week in an effort to counter massive sell-offs by investors, according to the Wall Street Journal.  If Italy can't attract investors and raise funds to honor its debt, Europe faces a much bigger challenge than it has been facing with Greece's debt struggles. 

Barry Eichengreen, professor of Economics and Political Science at the University California at Berkeley, says the days of Germany's and France's leaders managing Europe's effectively are over.  At Project Syndicate, Eichengreen argues that the only option for Europe's leaders now is to bolster the ECB:

Specifically, the ECB must do much more to support economic growth. Its decision to cut rates by 25 basis points at the first policy meeting under its new president, Mario Draghi, is the one ray of light in an otherwise darkening sky. But 25 basis points are a drop in the bucket. With Europe headed for recession, the danger of rising inflation is nil. Still, given German sensitivities, Merkel should use her bully pulpit to reassure her public.

More controversially, the ECB needs to increase its purchases of Italian bonds. Unless yields on those bonds fall to German levels, there is no way that Italy’s debt arithmetic can be made to add up. But Draghi has indicated that he is reluctant to see the ECB become a lender to governments. Reassuring the markets by adopting structural reforms, he has observed, is properly the responsibility of those governments, not of the central bank.

But structural reforms cannot be accomplished overnight. Italy needs time to put its pro-growth reforms in place. Not providing that time would sound the death knell for the euro.

Here’s where the political cover comes into play. Merkel and Sarkozy need to make the case that if the euro is to become a normal currency, Europe needs a normal central bank – one that does not merely target inflation like an automaton, but that also understands its responsibilities as a lender of last resort.

Read Europe’s Darkness at Noon here.