‘Change course, Germany, or risk eurozone collapse’

The prime minister and Chancellor Merkel are at odds over the role the European Central Bank (ECB) should play, with Britain and France calling for it to become the lender of last resort to indebted countries and Germany fiercely resisting a proposal it believes would lead to inflation.

Philip Whyte, senior research fellow at the pro-European Centre for European Reform, told Channel 4 News: “Ultimately the hopes of the eurozone rest on the shoulders of the ECB. I’m in the Cameron/Sarkozy camp on that.

“If the ECB remains Germanic, the eurozone will break up. The ECB is the only institution that can do what is necessary, in the amounts available, to restore confidence in the eurozone.”

Ultimately the hopes of the eurozone rest on the shoulders of the ECB. Philip Whyte, Centre for European Reform

The ECB has intervened on the markets to buy the government bonds of countries like Italy, which are facing punitive borrowing rates. But its actions have been limited and have not led to a fall in borrowing costs.

Mr Whyte said: “The ECB has engaged in government bond purchasing, but has signalled its reluctance to do so. The financial markets have never believed the ECB is behind this. It has to persuade the financial markets that it’s serious about this. It has to tell the markets that this is going to be unlimited.”

The ECB and Germany argue that its purpose is to control inflation, but Mr Whyte said it would be disastrous if the bank did not assume a bigger role.

‘Eurozone will fall apart’

“The ECB is saying it’s much more worried about its mandate than the future of the eurozone. It’s been dragged into a role it doesn’t want to carry out and the Germans don’t want it to carry out. But the eurozone will fall apart.”

With the borrowing costs of countries like Holland, Austria and Finland rising, “the markets are signalling a total lack of confidence in the eurozone,” according to Philip Whyte.

Germany is also resisting a more muscular role for the ECB because it believes indebted countries would have less incentive to reform if they assumed they would be rescued. It is insisting that Greece and Italy, which are being run by unelected technocrats, continue cutting spending and increasing taxes to balance their budgets, despite the public protests against these austerity measures.

Mr Whyte said: “Germany is a reluctant leader, but a self-righteous reluctant leader. It doesn’t quite understand what political and economic damage the adjustments they are seeking are having for others, weakening democracy in Greece and Italy.

“I sometimes wonder whether Germany is aware of the external consequences of the policies it is prescribing.The attempt to turn the eurozone into a larger version of Germany is turning the eurozone into a depression.”

Why is Germany opposed to a bigger role for the ECB?

Much has been made of Germany's supposed fear of hyper-inflation, the curse that afflicted the country in the 1920s before the rise of Hitler. The theory is that allowing the ECB to print money to bail out indebted eurozone economies would push up inflation.

But Dr Waltraud Schelkle, a political economist at the London School of Economics, believes the concept of German historical "trauma" is exaggerated. "I don't think it is so much about trauma about the 1920s. Our memories are as short as everybody else's. In the post-war years, our experience is that low inflation keeps you competitive, it's good for employment, growth and living standards.

"It is a sound principle for running any economy that you don't inflate your way into stimulating the economy. Keeping inflation low makes you competitive."

Germany is the largest contributor to the ECB, providing 27 per cent of its funding. It is also responsible for almost half of the 440bn euro bailout fund used to support Ireland, Portugal and Greece.

On the financial transaction tax, Dr Schelkle said the Merkel government believed it would serve a "fiscal need" at a time of austerity. "It's a popular thing to seek at the moment because people are angry with the financial sector."

For Germany, which was on the receiving end of "unsolicited advice" from the British government about the eurozone crisis, it was a case of "tit for tat". The Germans were asking the British: "What are you going to do about this crisis that got us into this mess? If this reduces the financial sector, so much the better."

Dr Schelkle said Germany and Britain had different approaches, with Berlin seeing exports as the route to a strong economy and London overly reliant on the City. "The Germans cannot get off their export model and the Brits cannot get off the financial model."

Financial transactions tax

Another area of disagreement between Mr Cameron and Chancellor Merkel is the proposed EU financial transactions tax, which the British government argues would have a disproportionately negative effect on the City of London as Europe’s most important financial centre.

I think the motive for the tax isn’t as pure as French and German politicians like to imply. Philip Whyte

Germany has floated the idea of the tax being adopted by the 17 members of the eurozone, rather than all 27 members of the EU. But Mr Whyte said Britain would still be affected.

“It could hit the City if transactions between institutions in London and the eurozone are subject to the tax, which presumably they would be. A lot of European politicians think the City is a threat to stability and the future of the eurozone. I think the motive for the tax isn’t as pure as French and German politicians like to imply. It would affect the UK disproportionately and is not the answer to what is ailing the eurozone.”

Repatriation

On 24 October, 79 Tory MPs defied a three-line whip to vote for a referendum on Britain’s membership of the EU, and the pressure on Mr Cameron to take a tough line on Europe has continued.

Some Conservative backbenchers are lobbying for the government to repatriate powers from Brussels. Writing in the Daily Telegraph, David Davis, a former Conservative leadership challenger, said Britain should be handed back control over migration, justice, business regulation and trade.

Mr Whyte said it was understandable other EU countries were irritated by these demands at a time the eurozone was in turmoil. “I would say this is an area where European politicians have most reason to gripe. It is seen as an incredibly hostile act at a time the eurozone is going through an existential crisis. Backbenchers in the Tory party are clamouring to hold any treaty changes to ransom.”