Merkel, Rehn Warn Against “Debt Fueled” Growth

The German chancellor and Europe’s top economic official caution against more borrowing.

Both Europe’s top economic official and German chancellor Angela Merkel warned eurozone governments this week against further borrowing to pay for stimulus measures.

“We cannot solve this crisis by piling new debt on top of old debt which is already damaging our economic growth prospects,” Olli Rehn, Europe’s commissioner for economic and monetary affairs, said in panel presentation at a conference in Tallinn, the capital of Estonia which adopted the common currency in January of this year.

Merkel told the Hamburger Abendblatt earlier in the week that Europe had to “get away from the idea that it always costs money to get economic growth.”

She reiterated that sentiment in parliament in Thursday. “Growth through structural reforms is sensible, important and necessary,” according to Merkel.

Growth on credit would just push us right back to the beginning of the crisis and that is why we should not and will not do it.

The German leader suffered a setback the next day when the left-wing majority in the upper chamber of parliament rejected her plan to reduce income taxes by €6 billion next year.

The ruling German conservative and liberal parties have not had a majority in the Bundesrat since May 2010. Socialist and Green parties in opposition are increasingly critical of their austerity agenda. Social Democratic Party leader Frank-Walter Steinmeier urged the government two months ago to enact “additional measures to promote economic growth.” His party has been emboldened by socialist François Hollande’s election win in France.

Merkel’s and Rehn’s warnings were clearly aimed at preempting the newly-elected French president’s push for a growth pact that would enable national governments to spend more freely to stimulate economic activity. Hollande has been critical of the strict fiscal rules that were enshrined in a European treaty in December.

Eurozone governments have now to submit their spending plans to the European Commission for approval. If they fail to adhere to the deficit cap of 3 percent of gross domestic product, the commission drafts an alternative budget. Countries that do not implement it could be subject to a fine.

Rehn, whose department is the recipient of governments’ budget proposals, insisted that Europe stays the course. He added, “we are suffering from a very high level of public debt which has increased from 60 percent on average to 90 percent in Europe.” Particularly in the periphery of the single currency area, countries have racked up enormous debts.

“The only sustainable path,” said Merkel, “is to accept that getting over the crisis is a long, strenuous process which will only succeed if we tackle the causes of the crisis which are the horrendous debt and the lack of competitiveness of some eurozone states.”

In conjunction with debt and deficit limits, the Germans have sought to enhance competitiveness across the eurozone with lower taxes, liberalizations and labor market reforms.

Greece, Italy and Spain have made progress in these areas but say that they need more time for fiscal consolidation and more flexibility on the part of the European Central Bank to finance their deficit spending before they’re able to balance their budgets. The Germans are highly critical of this proposition because it would drive up inflation.