Europe's Ideological War: Battle Over Spending and Stimulating Demand or Shrinking Public Sectors

An ideological war is still being waged at the heart of Europe and it has manifested itself in the European Commission's contradictory policies over inflation.

Demand in the Eurozone is anaemic. The latest reading shows inflation fell to a five-year low, bottoming out at 0.3%. This is miles below the European Commission's target rate of 2%.

For months, economists of all stripes have been calling for decisive action from whichever official source Brussels can call upon and this week, finally, some progress has been made.

The European Commission President, Jean-Claude Juncker, unveiled a €315bn (€251bn) infrastructure investment package. Just €21bn of this will come from the EU, with the rest, Juncker hopes, to come from the private sector, attracted by public guarantees and lucrative projects. Many have claimed this is not nearly enough.

President Mario Draghi used a speech in Helsinki to tell Europe the European Central Bank (ECB)'s asset purchasing scheme would be expanded to cover "all assets". This was music to the ears of those who had been calling on the bank to buy up corporate and sovereign bonds. In the coming days, we will hear more about the ECB's quantitative easing plans and in the new year, it will start printing more actual money.

Simultaneously, the commission issued warnings to a host of European governments – saying if they did not address their budgetary problems, the miscreants would face heavy financial penalties. France, Italy, Spain, Austria, Belgium and Malta could all be fined billions of euros, with the European Commission also set to request they sell off public assets and embark on austerity budgets.

So on a multilateral level, the commission wants to be fiscally expansionary. It wants to spend money in order to stimulate demand. On a domestic level, though, it is censuring governments who wish to do exactly that – calling for them to cut costs and shrink the public sector.

So spend or cut costs?

"There clearly is a contradiction," Jonathan Portes, director of the National Institute of Economic and Social Research (NIESR), told IBTimes UK. "All sensible economists in Europe realise monetary expansion and a relaxing of austerity is what is needed."

A common view is the commission is paying lip service to the German government. The Stability and Growth Pact dictates each of the EU's 28 member states must meet budgetary targets and must not exceed debt limits. The main enforcers of this are in Berlin.

"The soundest economic policy would be to say to Mrs Merkel behind the scenes: 'Look you're taking a reckless gamble with the future of the euro with these policies. Is that really what you want?' This is not rocket science. Everybody gets it," Portes said.

The other side of the argument is the European economies, particularly France and Italy, are in an economic mess. Supporters of the stability pact think the commission's dual policy of local austerity and regional expansion are not contradictory but necessary.

"The ECB's responsibility is to deal with price stability, but government's is to provide a stable fiscal framework and do what it takes to promote growth, not price stability," says Christian Schulz, senior economist at Berenberg Bank – a German financial institution.

Deal with economic structure first

Schulz's argument ties in neatly with that of the German government: the most serious problems in the most struggling European economies are structural and no amount of money thrown at them will lead to success until these problems are addressed.

"If you cut government intervention in markets and leave more room for the private sector, if you privatise companies there are plenty of steps government can take, especially in those countries where the government share is very high, to boost growth while continuing to fix the fiscal situation," he said in a telephone interview.

The main issues are in the labour market. France and Italy are two of the only Eurozone countries with rising unemployment. Yet, labour costs per unit are higher than in Germany. Schulz calls for lower minimum wage (although he realises this would be politically impossible) and better flexibility for companies to hire and fire as they need to.

"What is palatable politically has rarely been the same as the best economic medicine," says Mike Jakeman of the Economist Intelligence Unit.

And here we can see the crux of Europe's ideological divide. One side is sticking rigidly to its fiscal responsibility guns, even while others are crying out for financial help.

On the other side, even Juncker's investment fund is viewed as an exercise in appeasement: just 6% of the actual stimulus comes from public coffers, with the rest set to be contributed by the private sector.

The commission, says opponents, is kowtowing to Germany. There is frustration on both sides.

"I agree that France needs structural reform in a lot of areas. The labour market is a mess. But that's something we do over ten years. The idea that the main problem at the moment right now is structural, or the solution is structural doesn't fit with any evidence," Portes says.

"It would probably be helpful to confidence if France could get its act together and have reform, but that would be helped by demand. Structural adjustment would be a useful complement to that."

That Europe is divided is not news. But what is interesting is that the divisions still run so deep. And at a time when the intervention required is so drastic, baby steps and placation are unlikely to provide any real solution.