MADRID — After more than a year of aggressive budget cutting by European governments, an economic slowdown on the continent is confronting policymakers from Madrid to Frankfurt with an uncomfortable question: Have they been addressing the wrong problem?
The campaign to reduce government deficits has come in response to a European debt crisis that could endanger the global banking system. And the budget cutting has been coupled with a reluctance by the the European Central Bank to stimulate economic growth like the Federal Reserve has in the United States; the ECB has instead raised interest rates twice this year to contain inflation.
Fiscally sound in Spain
Sept. 1 (Bloomberg) -- Holger Schmieding, chief economist at Joh. Berenberg Gossler & Co., talks about the outlook for the German economy. He speaks with Francine Lacqua on Bloomberg Television's "Countdown." (Source: Bloomberg)
FAQ: Europe’s debt crisis
Those steps have sucked hundreds of billions of dollars out of a European economy that may be edging towards recession.
Such a downturn, by choking off government revenues and increasing the demand for public services, could put struggling countries such as Spain and Italy at risk of missing the very deficit-reduction targets that budget cuts and other austerity measures were meant to achieve.
In the United States, political and economic leaders are facing the similar dilemma of how to rein in the massive federal debt by enacting deep and immediate spending cuts without undermining already anemic economic growth.
This is the challenge confronting the White House as President Obama seeks to strike a balance between his promise to help tame the national debt and his new jobs initiative, which he wants to announce next week before Congress. So, too, a newly appointed bipartisan committee of lawmakers must figure out by Thanksgiving how to shrink the federal deficit by least $1.2 trillion even as many economists urge the government to do more to prevent another recession.
The perils posed by government debt are even more pressing in Europe. Bond markets are testing countries — and indeed the euro zone as a whole — with higher borrowing costs. This is putting pressure on governments to show they can control deficits and pay their bills. At the same time, deficit control measures have been fast and sharp — pay cuts, layoffs, tax hikes and other steps that are a drag on growth.
This approach has been successful in helping to keep debt problems that began nearly two years ago in Greece from spreading to the continent’s largest economies. And there’s widespread agreement among economic analysts and officials that debt levels have become unsustainable in some countries and are raising concerns about the health of banks that hold European government bonds.
But the one-size-fits-all approach in Europe may ignore the trade-offs between government austerity and growth.
In Spain, for instance, where the parliament this week is voting to place constitutional limits on government deficits in a bid to reassure global investors, some analysts say the country is taking the wrong medicine. Spain’s debt level remains lower than even that of Germany, the continent’s strongest economy and one of the world’s benchmark credit risks. But Spain’s unemployment rate is more than double that of the United States, and some economists say the country needs a healthy dose of policies to restore growth, not constrain it.