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Austerity debate flares as Europe recovery fades

By Lori Hinnant

Associated Press

Published: Monday, Sept. 1 2014 10:17 a.m. MDT

French President Francois Hollande, right, shakes hand with President of the European Central Bank, Mario Draghi, after a meeting at the Elysee Palace, in Paris, Monday, Sept. 1, 2014. Bank chief Mario Draghi called in a speech last month for fiscal policies to support growth, a departure from the ECB's implicit support for austerity. No immediate steps were expected but the bank has begun work on a program to buy asset-backed securities.

Jacques Brinon, Associated Press

FRANKFURT, Germany — Europe's recovery is in danger. Governments are under pressure to save it, but struggling with political obstacles and disagreement among themselves over what to do.

Instead, the region is pinning its hopes — once again — on the European Central Bank, which is expected to launch new stimulus measures if the economy gets any worse.

Europe's lack of growth is looming larger and larger, however, and the ECB says it can't save the economy alone.

For more than five years since the eurozone hit turbulence over too much debt in 2009, governments' answer has been to raise taxes and restrain spending. And there's been some progress. Deficits have shrunk, and countries that needed bailout loans are slowly getting their act together.

But second quarter growth was zero, after only four quarters of measly expansion. While unemployment in the United States has fallen to 6.2 percent from 10 percent at its peak in Oct. 2009, Europe's is at 11.5 percent — still near last summer' 12 percent. The risk is Europe remains stagnant for years — bad news not just for its people but also its three major trading partners: the U.S., Britain and China.

As worries spread, the debate over austerity versus growth is sharpening again. EU leaders will meet Oct. 6 to discuss growth, while the ECB will hold a policy meeting Thursday at which it is expected to flag its willingness to announce more stimulus such as bond purchases.

ECB President Mario Draghi is ringing the alarm.

He says the central bank can't do it all alone and that governments should dial back austerity, withing EU rules aimed at restraining deficits. "It would be helpful for the overall stance of policy if fiscal policy could play a greater role alongside monetary policy, and I believe there is scope for this," Draghi said in a speech last week. Government spending can help boost growth by providing demand when the private sector is struggling.

Draghi's not the budget boss, however. Each of the eurozone's 18 member governments decides its own spending. Germany, Europe's biggest economic and political power, and Chancellor Angela Merkel are sticking with the emphasis on austerity. Countries with extremely high debt, such Italy, are under pressure to keep the lid on spending.

Here's a look at Europe's dilemma.

IN THEORY: Some economists think much more needs to be done. Francesco Giavazzi and Guido Tabellini at Bocconi University in Milan say the 18 eurozone governments should do a coordinated 5 percent tax cut, spread their budget balancing efforts over an extra 3-4 years, and issue long-term bonds that the ECB would buy. That's unlikely to happen, as such steps would run into legal and political objections.

But the proposal is a sign of how much stimulus some think is needed.

If YOU BUILD IT: Draghi backed a proposal by Jean-Claude Juncker, the incoming head of the EU's executive commission, for a 300 billion-euro ($394 billion) fund to invest in infrastructure such as roads, bridges and ports, drawing on existing EU funds and private investment. Governments, particularly Germany with its balanced budget, could do the same. If they want to, governments could borrow cheaply. Bond interest rates are very low. Germany's 10-year bonds yield a rock-bottom 0.89 percent. Even Ireland, bailed out in 2010, faces yields under 1.8 percent — below even 10-year U.S. Treasurys at 2.34 percent.

"From a market perspective, they have an enormous amount of room," said Jacob Funk Kirkegaard, an economist with the Peterson Institute for International Economics in Washington, DC. "There is a good argument that many are making that governments should make the most of that room and take out some more debt and invest more in infrastructure, education and other things."

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