Recession upends germany’s zeal for fiscal prudence

 It has come to this: Germany will almost certainly have a bigger budget deficit next year than Italy will.

 Traditionally, Germany is the Continent’s keeper of fiscal rectitude, perpetually fretting that the Italians and other free-spending southern Europeans are about to undermine the euro and rekindle inflation by not reducing their red ink.

 But in 2010, the Germany deficit is expected to total 6.5 percent of its gross domestic product, while the Italian budget gap is forecast at 6.2 percent of GDP, according to Deutsche Bank.

 “There is something really odd going on here, with Italy being more prudent, Spain getting more serious and even the French talking about pension cuts,” said Gilles Moec of Deutsche Bank. “Germany is the odd one out.”

 It is more than a matter of role reversal.

 The German shift underscores just how profoundly the economic and political situation has changed in Berlin, as well as how desperate Chancellor Angela Merkel is to restore growth in Europe’s largest economy as she begins her second term.

 Given the long-standing aversion to borrowing and spending that has shaped German fiscal policy since the great hyperinflation of the Weimar era during the 1920s, Merkel and her new finance minister, Wolfgang Schaeuble, have set off a fierce debate by proposing to cut taxes by 24 billion euro, or $35.9 billion, in 2010 and 2011, rather than immediately attack the country’s projected budget gap.

 Cutting taxes now and balancing budgets later is a high-wire act for all politicians, of course, and the new German government is divided even within its own ranks over the wisdom of lowering taxes to stimulate the economy.

 But it is a sign of just how painful the recession has been across the Continent, especially Germany, that officials in Berlin and elsewhere in Europe are so reluctant to reduce borrowing anytime soon because of the risk of harming the incipient recovery.

 Like Germany, much of Europe is struggling with how to gradually withdraw economic stimulus efforts without compounding still-rising unemployment or throwing their economies back into recession.

 The terms of the treaty that created the euro currency are supposed to limit each country’s deficit to no more than 3 percent of its GDP. None of the 16 countries that use the euro are expected to meet that goal soon, however, with the typical budget deficit projected to reach a record 6.9 percent of GDP next year, according to the European Commission.

 On Wednesday, the commission is expected to give Germany, France and Spain until 2013 to return their budget gaps to below 3 percent.

 But it is not clear whether any of them can achieve that goal. For Merkel, who strenuously opposed a Europe-wide stimulus package during the depth of the financial crisis last year, the change of approach has been difficult to accept.

 “Germany has been a kind of symbol for Europe of caution and prudence when it comes to spending,” said Alfred Boss, an economist and specialist in German politics at the Kiel Institute for the World Economy, who added that Berlin’s new proposals “are not typically German.”

 “There seems to be a kind of attitude that the tax cuts will finance themselves,” he argued. “It’s nonsense. It’s an attitude prevailing in the U.S., but this kind of thinking seems to be stronger in the new government.”

But for all the efforts to keep everybody united, Merkel could be on a collision course with much of the business community, as well as Axel A. Weber, the head of the Deutsche Bundesbank, who sits on the governing council of the European Central Bank in Frankfurt.

 In an October speech, Weber set 2011 as a crucial deadline for Europe to begin digging out of the stimulus measures and deficit spending now under way.

 “Given the enormous rise in public deficits and the strain this will put on future budgets, the fiscal exit strategy will have to kick in as soon as the recovery has firmed up, which means no later than 2011,” he said.

 Among ordinary Germans, the desire for fiscal discipline still runs deep as well, setting the stage for further tensions down the road if the economy lags.

 A poll published in October by Forsa, the independent polling institute, showed that only 22 percent wanted tax cuts if they would lead to a wider budget deficit and more public borrowing. Nearly 70 percent were against the idea.

 Moreover, a new law limits federal deficits to 0.35 percent of gross domestic product from 2016 onward and no longer allows the federal states to run deficits at all from 2020 onward.

 But Markus Heintzen, economics professor at the Free University in Berlin, reckons such targets will now be very difficult to meet.

 “Traditionally, inflation, that has been more important to Germans than government borrowing,” Heintzen said. “But now, look at the way the states and local governments have run up huge debts and deficits. The public knows it is worrying.”