European leaders shift to softening austerity pressure

FRANKFURT - The Associated Press

German Chancellor Angela Merkel (2nd L) speaks with French President Francois Hollande (2nd R) during a round table meeting at an EU summit in Brussels on March 15. AP photo

Three and a half years into its government-debt crisis, there are signs that Europe is adopting a gentler approach toward austerity.

Political leaders aren’t backing away aggressively from budget cuts and higher taxes, but they are increasingly trying to temper these policies, which have stifled growth and made it harder for many countries to bring their deficits under control.

The European Union is slowing its enforcement of deficit limits until the region’s economy turns around; countries that were bailed out by their European neighbors are being given more time to repay loans, easing the pressure to cut budgets further; and financial leaders, including the head of the European Central Bank, say it’s time to place more emphasis on reviving growth.

“There has clearly been a shift in thinking,” says Christian Schulz, economist at Berenberg Bank in London.

Slashing spending proved to be wrong

After the crisis broke out in late 2009, governments dramatically slashed spending - either to meet conditions for bailout loans, or to reassure jittery bond markets that they were trustworthy borrowers. This fiscal belt-tightening was introduced to help countries reduce their deficits and pave the way for critical financial aid.

Promises of austerity gave the ECB political breathing room to get more aggressive. The bank’s pledge last summer to buy unlimited amounts of government bonds is largely responsible for taming Europe’s financial crisis.

But austerity also inflicted severe economic pain in places like Greece, Ireland, Portugal, Spain and Italy. Over time - as the economy of the 17 European Union countries that use the euro descended into recession - evidence grew that slashing spending and raising taxes were less effective at reducing deficits than initially thought, and perhaps counter-productive.

Why? Because as economies shrink, so do tax revenues, making it harder to close budget gaps.
The latest eurozone recession, which began last year, is forecast to end in the second half of this year and was the main focus of European Union leaders’ summit in Brussels.

“We are all fully conscious of the debate, the mounting frustrations and even despair of people,” said Herman Van Rompuy, president of the European Council, after the meeting ended.

“We also know there are no easy answers.”

With unemployment at a record 11.9 percent and Europeans expressing their discontent at the polls and in the streets, many of the region’s political and financial leaders are willing to postpone budget-cutting and deficit targets.

EU officials have hinted Spain, France, Portugal and Greece might be allowed more time to reduce their deficits to within the limits specified by European Union rules, can be named as an example.

Moreover, European finance ministers last week agreed in principle to grant Ireland and Portugal more time to repay bailout loans to other eurozone countries. While the countries cannot abandon deficit-reduction plans they agreed to in return for loans, it does allow them to cut budgets more slowly.

ECB President Mario Draghi last week urged indebted governments to move beyond spending cuts and tax hikes and introduce labor reforms and other measures that would boost growth and reduce the “tragedy” of unemployment.