Germany calls for less restrictive monetary policy to revive economy

Germany has blamed high inflation in some euro-zone states for the European Central Bank's (ECB) reluctance to cut interest rates to boost economic growth. Mr Caio Koch-Weser, Germany's deputy finance minister, told the World Economic Forum in Davos that his country's sluggish economy needed a less restrictive monetary policy.

The ECB hinted this week that it would leave interest rates unchanged at its next governing council meeting in two weeks. But analysts believe that the strengthening euro, which tends to dampen inflation, will encourage the ECB to cut rates in March.

Mr Koch-Weser said the EU should take more seriously divergent inflation rates within the euro zone and encourage governments to take appropriate action. He defended the Stability and Growth Pact, although Germany has already breached its 3 per cent ceiling on budget deficits. "In the absence of a strong, central fiscal authority, it's the best we can do. I see no contradiction between the pact and growth," he said.

France this week received a formal warning from EU finance ministers that it is in danger of breaching the pact and Italy is also believed to be straining at the 3 per cent budget deficit limit. Germany, France and Italy between them account for more than 70 per cent of the euro-zone economy.

Mr Koch-Weser claimed France and Italy still had scope to cut public spending to bring their deficits under control. But he said there was no room for further tightening in Germany.

"We made it very clear that, with the very heroic adjustment we're making, we can't do more if growth is lower than 1.5 per cent. I can tell you it will be 1 per cent," he said.

Prof Robert Mundell, a Nobel Prize winner for economics and the world's foremost expert on currency unions, agreed that the pact was necessary. "I would not change the pact but I'd interpret it more liberally. There's nothing magic about balancing the budget in a year. You might just as well say a month."

It would be better to look at the business cycle, he said.

Prof Mundell acknowledged that the US had no such mechanism but he said that, because the euro was a new currency and because the euro-zone economy was dominated by three big states, the situation was different. "If one big state went bankrupt, it would have a terrible effect on Economic and Monetary Union," he said.

Prof Mundell suggested the cause of Europe's low level of economic growth lay in the huge increase in government spending in recent decades. He said the EU could best promote growth by imposing a ceiling on government spending by member-states.

Mr Gerard Kleisterlee, president and chief executive of Dutch electronics giant Philips, agreed the pact should be interpreted more flexibly. He said that, before the euro was launched, it had been important to emphasise stability but it was now time to shift focus.

Mr John Evans, general secretary of the Trade Union Advisory Committee to the OECD, said the pact should be renamed the Stability, Growth and Employment Pact. He said it was not enough to tell governments to cut spending; it was necessary to examine the quality of public spending.

"The pact has to be developed into something that is good at avoiding recession," he said.

Mr Evans called on EU leaders to make economic growth their priority, starting with their next meeting in Brussels in March.