Austerity becomes a dirty word in Europe

What’s next for France and Greece?

Laurent Cipriani/Associated Press
French president-elect Francois Hollande, waving to Parisian crowds Sunday after his victory, is viewed as the continental leader of a backlash against austerity budgets across an economically fragile Europe. “Austerity can no longer be inevitable!” he shouted in his first speech. Enlarge photo

Laurent Cipriani/Associated Press French president-elect Francois Hollande, waving to Parisian crowds Sunday after his victory, is viewed as the continental leader of a backlash against austerity budgets across an economically fragile Europe. “Austerity can no longer be inevitable!” he shouted in his first speech.

PARIS – The day after Francois Hollande rode to power in France on a slogan of “change now” the conversation in Europe is already different: Austerity has become a dirty word.

In Greece, political parties that reject the extreme belt-tightening required by international bailouts were the big winners in parliamentary elections. German voters in a northern state ousted the coalition led by Chancellor Angela Merkel’s conservative party, which has pressed the case for austerity.

And France, of course, elected Hollande, its first Socialist president in more than a decade and one who has promised more government spending to stimulate the economy.

“Austerity can no longer be inevitable!” he shouted in his first speech after Nicolas Sarkozy conceded Sunday night. The question remains whether Germany – which is Europe’s economic powerhouse driving the austerity agenda – will allow at least some countries in the eurozone to spend more freely in the face of a recession that is spreading across the continent.

Rising uncertainty over how Europe’s handling of the debt crisis may change in the weeks and months ahead has made investors nervous. Stock markets were volatile Monday, falling sharply in the morning and recovering in some countries by the close.

The sharpest selloff was in Greece, where the main stock index plunged almost 7 percent. The euro briefly spiraled to a three-month low against the dollar, hitting $1.2972.

More turmoil in the eurozone would affect the global market, particularly countries like the U.S. whose financial system is intertwined with that of Europe.

As investors become nervous about the future they pull back on their investments, hurting economic activity, while drops in stock markets drain wealth from savers.

American exporters would suffer if sagging confidence in Europe shrinks the value of the euro against the dollar. Exports have been one of the U.S. economy’s few strengths since the recession ended three years ago.

The most nerve-wracking development occurred in Greece, where political parties that backed two bailouts lost their majority in Parliament. That opens the possibility that Greece’s new leaders could renege on commitments made to secure the country’s massive rescue loans – or even decide to leave the euro. The conservatives will try to put together a new government, but there’s a good chance they could fail – and that would usher in another month of financial chaos before new elections.

Merkel pressed Greek leaders to stay the course.

“Of course, the most important thing is that the programs we agreed with Greece are continued,” she said Monday.

But Greece isn’t the only problem. The 17 countries that use the euro – and nine other European countries – agreed in March to a fiscal compact that seeks to make countries balance their budgets. But as Europe’s economy gets weaker, the public and politicians are growing weary of the budget-cutting that is required to make this fiscal compact work.

Eight of the 17 eurozone nations are already in recession and unemployment across the bloc rose to 10.9 percent in March – its highest ever.

If investors pull back from Europe amid uncertainty, its growth policies will have trouble making headway – and that could also drag on the global economy.

The U.S. and European Union are important trading partners and each consumes a large portion of the other’s exports. With unemployment skyrocketing in Europe, consumption is flagging and that will have a knock-on effect on the U.S.

The American and European financial systems are also heavily intertwined, and U.S. money market funds still have significant exposure to Europe.

Over the past two years, France and Germany have steered Europe through the debt crisis – though not always well – and declared an end to the flouting of deficit limits that led Europe into the debt crisis.

But the crackdown could not have come at a worse time – with the world economy slowing – and propelled Europe into a vicious austerity spiral. Cutting spending – which meant laying off state employees and ending stimulus programs – further slowed nations’ economies and produced less tax revenue, which meant more cuts were needed to meet deficit targets.

Now a backlash has begun and for many, Hollande is its leader.

The new French leader has promised to end the negative loop, demanding that the fiscal compact that targeted spending be re-negotiated to include measures to promote growth. Many economists have long advocated for a greater emphasis on growth, but that idea seemed to gather steam among European policymakers only as Hollande promoted it.

“At the moment that the (French vote) result was proclaimed, I am sure that in many European countries, there was relief, hope,” he told supporters in his central hometown of Tulle.

European Central Bank President Mario Draghi called for a “growth compact” even though that institution has long demanded fiscal discipline. The Dutch government, long a supporter of such discipline, fell over the issue of too much austerity and too little growth. And even Germany, the primary architect of austerity, has said a growth pact should be drawn up.

Still, concrete proposals for stimulating short-term growth have been few. European officials have talked about boosting funding for the European Investment Bank, and economists have urged making more targeted and aggressive use of EU structural funds for infrastructure projects such as roads.

Yet with a budget only around 1 percent of EU gross domestic product, the EU’s prospects for large-scale spending are limited.

Jeffrey Bergstrand, a professor of finance at the University of Notre Dame, said Germany is going to have to shift on the subject of stimulus. Even though its economy is the largest – and among the strongest – in Europe, it can’t thrive if no one else is.

“Merkel has to be paying attention to (unemployment) because Germany, unlike the United States, is very, very reliant on exports, and exports tend to go to your neighbors,” he said. “She will have to listen. She will have to give.”