Euro Zone Cuts Deeper Amid Criticism

WSJ: FRANKFURT—Europe is pressing ahead with fiscal belt-tightening amid mounting criticism from economists and political leaders that the strategy is hurting the region's fragile economy.

The argument is entering a decisive phase as Europe teeters on the brink of a new recession. Manufacturing contractions in March extended from the Mediterranean periphery to powerhouses including Germany and the Netherlands, according to business surveys. Euro-zone unemployment climbed to 10.8% in February, the European Union's statistics agency said this week, a euro-era high.

Spanish Finance Minister Luis de Guindos complained this week that his country faces a "lose-lose situation," where financial markets expect him to slash Spain's budget deficit, but the impact of austerity on the economy could also undermine investor confidence.

Italian Prime Minister Mario Monti and International Monetary Fund head Christine Lagarde have called for more growth-friendly policies in Europe's healthier economies, to offset the deep fiscal retrenchment on the euro-zone periphery.

Amid concerns about Italy's worsening economic outlook, industry minister Corrado Passera said on Tuesday that his government won't cut spending any deeper than it already has, adding: "With austerity, one doesn't grow."

So far, such voices are failing to move the euro zone's strongest players, the European Central Bank and Germany, which continue to insist that austerity for all, coupled with long-term structural overhauls of economies, is the only way to end the currency bloc's debt crisis.

The ECB, which is expected to keep interest rates unchanged at Wednesday's monthly meeting despite the weakening economy, has long argued that austerity can boost growth by reassuring businesses and consumers about governments' financial health.

"Consolidation might inspire confidence and actually help the economy to grow," Bundesbank head Jens Weidmann, a member of the ECB's governing council, said last week. Mr. Weidmann said critics' concerns about austerity are "exaggerated," adding: "In any case, there is little alternative.…The only promising approach is to 'cut' your way out" of debt.

Even critics of austerity concede that some indebted countries, facing high and volatile borrowing costs in financial markets, have no choice. Spain and Italy may thus have to bow to market pressure and slash their deficits, even at an economic cost, to prove they are serious about fiscal discipline, economists say.

But other countries, such as the Netherlands and France, are also under pressure from EU authorities to cut their deficits quickly despite low borrowing costs.

Many economists say they are in danger of unnecessarily imitating the growth-sapping austerity imposed on countries such as Greece and Portugal, which have lost access to bond markets.

The IMF and others have long argued that austerity hurts growth, at least in the near term. Now a growing number of economists say that for many countries, austerity isn't an effective way of balancing the budget in the longer term.

rad DeLong, an economics professor at University of California, Berkeley, has researched the effects of fiscal policy together with former U.S. Treasury Secretary Lawrence Summers.

Their finding: In a depressed economy where interest rates are low, budget cuts that prolong a recession undermine tax revenues, erasing the fiscal benefits of the initial cuts.

"This was the astonishing thing we found when we began doing the arithmetic seriously," Mr. DeLong said in an email.

In countries with low borrowing costs, such as the U.S., Germany, France and the Netherlands, the lost economic activity from austerity makes public debts harder, not easier, to bear, he said.

Dutch officials are weighing budget tightening despite a bleak economic outlook and relatively low public debt. The 10-year government bond yields 2.3%, roughly the same as the U.S. Meanwhile, France is pursuing tax increases and spending cuts even though it borrows 10-year funds for around 2.8%.

Austerity is "a big mistake in these countries where the cost of financing is so low. It's the time to invest," said Paul De Grauwe, an economics professor at Belgium's Catholic University of Leuven.

Britain, an EU member that isn't part of the euro, has also been on an austerity drive, in 2010 embarking on a multiyear plan to cut tens of billions of pounds of welfare and other spending. Some analysts say the measures have bolstered financial-market confidence and kept borrowing costs down.

However, the U.K. has moved at a slower pace than other European countries with large budget deficits. Britain's deficit, though down from two years ago, is still around 8% of gross domestic product.

The U.K. also has policy tools to prop up growth that euro-zone countries lack. The lower value of the pound has made exports more competitive.

The Bank of England has offset fiscal austerity by purchasing large amounts of government bonds to keep interest rates low.

"Even given those things, we're failing to generate any growth," said Richard Barwell, economist at RBS in London. "It's a cautionary tale for Europe."

—Cassell Bryan-Low contributed to this article.

Write to Brian Blackstone