EU chooses Spain to start shutting down austerity policy

France and Italy add support to greater flexibility on budget deficits and new focus on reforms

Doing politics is to tell stories. A country — never mind a continent — cannot be transformed without a convincing narrative. Aided by pressure from the markets, German Chancellor Angela Merkel has been ruling Europe for the last three years with a tale that blames the crisis on the fiscal misdemeanors of a handful of countries. Austerity, she promised, would redeem Europe through Berlin’s firm leadership; there were even scientific studies to support the austerity thesis (Alesina-Ardagna, Reinhart-Rogoff and others).

But the story, it turns out, was not quite true. Not even the economic models were flawless. The false tale — or The Great Unraveling, as Paul Krugman wrote — only held up in Greece’s case, and in the end the overdose of spending cuts has run into a stark reality: a general recession and a depression in the South, with soaring jobless rates and public debt levels. And while the euro’s existential crisis has disappeared (with the ECB’s help) and some of the imbalances have been mitigated, austerity has brought neither the growth nor the market confidence it promised.

The continent needs a new story, and the first chapter begins in Spain. The EU has chosen Madrid to make changes that reflect European leaders’ growing doubts and the groundswell of popular indignation in the countries hardest hit by the recession. It remains to be seen whether the changes will be real or merely rhetorical. But for now at least, Brussels will stop obsessing so much about deficit targets and instead focus on reforms. The point is to soften austerity policies, although critics of the European Commission (and there are many of them) think this is just a new name for the same thing.

The time has come to rethink that strategy, but it will not be clearly seen until after the German elections”

“I call it saving, balancing the budget. Everyone else uses the term austerity, which sounds like something truly bad,” said Merkel last week, attempting to find new terms for an unwavering rhetoric. “Recession and austerity bear no relation,” added her finance minister, Wolfgang Schäuble.

And yet something is afoot in Europe. “Reality is pushing the EU towards a new approach that is less obsessed with austerity. This is a very positive thing,” says Ashoka Mody, a former high-ranking official at the International Monetary Fund, now at Princeton University.

“Spain and other flagrant cases prove that the time has come to rethink that strategy, although the change will not be clearly seen until after the German elections,” a European source admitted.

Will this margin be enough for Spain, Portugal and France? The half a dozen sources consulted for this story said that it will buy some extra time, but that more economic stimulus will also be necessary, as well as European policies, which until now have been remarkably absent. And that means turning to Germany once again. But with just four months left before elections there, Merkel will not go any further for now.

“Her public opinion is not prepared for anything else, and besides, it has worked out all right for Germany,” said diplomatic sources.

And yet the tide of criticism keeps rising. Commission President José Manuel Barroso warns that austerity is reaching its own limits. Italy’s new prime minister, Enrico Letta, has called for an easing of austerity policies if Europe does not want to “lose all its credibility.” Meanwhile Bill Gross, chairman of PIMCO, one of the largest fixed income investment managers in the world, is telling Europe to spend if it wants to grow again. And a harsh French Socialist Party document calls on President François Hollande to fight the “intransigent selfishness” of Angela Merkel.

Charles Wyplosz of the Graduate Institute of International and Development Studies in Geneva, recommends that countries like Spain “freeze their structural deficits with neutral fiscal policies and wait for Merkel to admit that her strategy has failed, something she will not do until after the elections at least, or perhaps never.”

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