Debate Grows as Europe Fears Return of a Crisis

Angela Merkel, the Chancellor of Germany (Photo credit: Wikipedia)

BERLIN — The European financial crisis has shown signs of reigniting in recent days, sharpening the debate between the champions of austerity and a growing chorus urging more expansionary policies to promote growth.

Even the traditionally hard-line International Monetary Fund called on Tuesday for stronger European nations to ease the fiscal brakes by stretching out budget cuts over a longer period. But if that message was intended foremost for Germany, it seemed destined to fall on deaf ears: with two state elections coming up next month, Chancellor Angela Merkel is unlikely to shift her position, popular with voters, against additional help for the economies of struggling European partners.

“We don’t see the need that perhaps other countries see to boost growth through additional increases in expenditures,” said a senior official in the German Finance Ministry, speaking on the condition of anonymity.

“Instead, we see quite clearly, and will remind our partners about their responsibilities from Toronto,” the official said, referring to commitments made at the Group of 20 summit meeting in June 2010, “to cut their deficits in half and stabilize their debt levels.” At the same time, the official said that Germany hoped other countries would join in increasing the International Monetary Fund’s resources to help it combat the crisis.

Politics as much as economics is adding to the sense of uncertainty in Europe. President Nicolas Sarkozy of France, who is trailing the Socialist candidate François Hollande in the polls before the first round of the presidential election on Sunday, has joined his opponent in promoting pro-growth policies. In Greece, nationalist anti-German fringe parties are gaining strength ahead of next month’s parliamentary election.

The German state elections may not directly affect the federal government in Berlin, but they distract from Continent-wide concerns and crisis management while thrusting parochial issues to the forefront. The German government does not have a mandate to share further the burden of the common currency on less competitive economies like those of Greece, Portugal, Ireland and, increasingly, Spain and Italy.

What seems certain, however, is that the crisis will continue to fester until new measures are taken to address its root causes. Borrowing costs for struggling southern European countries like Spain and Italy have begun to rise again as the effect of the European Central Bank’s injection of about $1.3 trillion in cheap loans into the banking system in December and March has faded much faster than expected. The three-year loans were meant to buy time for struggling governments and financial institutions, but the breathing room appears likely to be measured in months rather than in years.

The recent shift has underscored that there have been no substantive fixes beyond promises by countries to reduce their budget deficits. “It looks like it’s coming back with a vengeance, largely because none of the underlying problems have been solved,” said Philip Whyte, a senior research fellow at the Center for European Reform.

Mr. Whyte said that despite two years of crisis management, the fundamental structure of the euro zone remained intact, with lower-productivity economies in the south yoked to higher-productivity economies in the north, which prevents the laggards from competing through a currency devaluation.

“The E.C.B. bought time, but what it ended up doing was simply tightening the link between national banks and their sovereigns,” Mr. Whyte said. “They made the system more vulnerable if markets started losing faith in debt sustainability in countries like Spain.”

Yields on Spain’s 10-year bonds climbed above 6 percent on Monday, though they fell slightly on Tuesday after a successful auction of short-term debt by Spain’s treasury. Spain has emerged as the central test this year after missing its deficit targets as it slips back into recession. The government in Madrid has had a difficult time reining in spending by the 17 regional governments.

A bailout of Spain would be much costlier than one for smaller economies like those of Greece, Portugal or Ireland, testing the resources of the euro zone countries. Many economists, particularly in the United States, have argued that Spain has to stimulate its economy with additional spending if it hopes to return to economic growth, an argument rejected by the German government.

In an interview with the German newspaper Frankfurter Allgemeine Zeitung on Tuesday, Christine Lagarde, the managing director of the International Monetary Fund, said she was concerned about the health of Spanish banks and warned against slashing spending too quickly. It is not a view shared here in the German capital.

In an interview with Reuters on Tuesday, Germany’s finance minister, Wolfgang Schäuble, praised Spain for making difficult economic changes. “You don’t win back trust overnight,” Mr. Schäuble said, adding that Spain was following the right path by cutting spending. German officials have also recommended changes in labor markets as a longer-term strategy to promote growth.

As deficits balloon in countries across Europe, Germany continues to watch its deficits and financing costs fall. In another sign of Germany’s recent strength, the Bundesbank said on Tuesday that the country’s debt had fallen to 81.2 percent of gross domestic product in 2011, compared with 83 percent in 2010. That is still far above precrisis levels: in 2007, German debt was 65.2 percent of the size of the country’s economy.

“The problem with the crisis in Germany is that we know we have a crisis, but we don’t feel it,” said Eckart D. Stratenschulte, a political scientist and the director of the nonprofit European Academy Berlin.

Even as the European Central Bank loans improved market conditions, European leaders, including Ms. Merkel, were clear that they did not believe that the crisis was over. Many in Germany argue that a sense of crisis — and the elevated borrowing costs that come with it — is necessary to end out-of-control spending in the heavily indebted nations and to push through the economic liberalization they need to restore growth.

But the higher borrowing costs and austerity measures cut into growth, critics say, lowering government revenues in a self-defeating downward spiral and leading to higher interest rates and further budget cuts. “It’s concerning that the markets are again running out of patience and driving yields higher,” said Thomas Mayer, chief economist at Deutsche Bank in Frankfurt. “That creates further head winds.”

The I.M.F. on Tuesday raised its forecast for global growth slightly for the year. In Europe, the fund projected recovery in the second half of 2012, except for Spain, Italy, Greece and Portugal, where substantial improvement is not expected until next year.

The crisis, Mr. Mayer said, is like “a manic depressive moving between euphoria and worries, and now we’re in the valley of worries again.”

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