Europe can, or should, spend its way out of the current downturn but that fiscal policy should avoid aggravating cyclical downturns. With luck that trend has now started Monetary policy in the euro zone has also been tighter than in America. Since the beginning of 2001 the European Central Bank(ECB)has cumulatively cut short-term interest rates by 2.75 percentage points whereas the Federal Reserve has cut short-term rates by 5.5 percentage points. Here, too, the differences are partly due to intellectual attitudes and partly to self imposed rules. Whereas Alan Greenspan, the chairman of the Federal Reserve, has adopted the role of recession-avoider-in-chief (in line with the Fed's goals of maximising employment as well as stabilising prices), Europe's central bankers have been dogmatic inflation fighters(their only official goal being inflation close to but below, 2%. they are also self-styled drill-sergeants for tructural reform Despite widespread criticism from the IMf, the oeCd and the financial markets for cutting rates too slowly, the ECB remains unabashed. Wim Duisenberg the bank,'s boss from its inception, once famously quipped that a bout of falling prices was a central banker's dream. He has regularly claimed that Europe's problems are structural, not monetary Jean-Claude trichet, a former governor of the Bank of france, who is expected to take over from Mr duisenberg in November, may take a softer line But it is not just a question of personality. a large part of the difficulty lies in making policy in a currency union of 15 disparate economies. The ECB's decisions on interest-rate changes are based on region-wide inflation averages, which across the euro zone as a whole have consistently bumped up against the ECB's target of 2%. However, inflation in Germany-which makes up 30% of the euro zone's economy-has been rather lower than the average. So interest rates that are appropriate for the euro zone as a whole are too high for germany To aggravate matters, Germany has a much weaker banking system than the rest. Like Japan, it has too many unprofitable banks that need rationalising and restructuring While this is being done, banks are reluctant to lend so credit growth is stagnant The pessimists about Europe say that the state of Germany,'s banks, its structural rigidities and its low inflation raise the spectre of Japan-style deflation that could sink the economic prospects of the entire euro zone Do trains pull locomotives? Optimists about Europe-of whom there are a few-suggest that whereas the ECB may not have loosened interest rates enough for Germany its cuts should be enough to get demand going again in the rest of the euro zone. Growth there, they argue, will eventually pull Germany along too. Analysts at Goldman Sachs for instance point out that real interest rates outside Germany are negative and that the euro zone as a whole has a relatively healthy balance sheet and little spare capacity. they reckon the ECB's rate cuts so far will be enough to boost the growth in domestic demand in France from 1.1% this year to 3. 1% next year and in Italy from 1.4%to2.9% Given Germany,'s weight in continental Europe the idea of robust European growth without Germany seems a stretch. But whether the macroeconomic optimists or pessimists win the day depends in large part on what happens to the euroEurope can, or should, spend its way out of the current downturn, but that fiscal policy should avoid aggravating cyclical downturns. With luck, that trend has now started. Monetary policy in the euro zone has also been tighter than in America. Since the beginning of 2001 the European Central Bank (ECB) has cumulatively cut short-term interest rates by 2.75 percentage points, whereas the Federal Reserve has cut short-term rates by 5.5 percentage points. Here, too, the differences are partly due to intellectual attitudes and partly to self￾imposed rules. Whereas Alan Greenspan, the chairman of the Federal Reserve, has adopted the role of recession-avoider-in-chief (in line with the Fed's goals of maximising employment as well as stabilising prices), Europe's central bankers have been dogmatic inflation fighters (their only official goal being inflation close to, but below, 2%). They are also self-styled drill-sergeants for structural reform. Despite widespread criticism from the IMF, the OECD and the financial markets for cutting rates too slowly, the ECB remains unabashed. Wim Duisenberg, the bank's boss from its inception, once famously quipped that a bout of falling prices was a central banker's dream. He has regularly claimed that Europe's problems are structural, not monetary. Jean-Claude Trichet, a former governor of the Bank of France, who is expected to take over from Mr Duisenberg in November, may take a softer line. But it is not just a question of personality. A large part of the difficulty lies in making policy in a currency union of 15 disparate economies. The ECB's decisions on interest-rate changes are based on region-wide inflation averages, which across the euro zone as a whole have consistently bumped up against the ECB's target of 2%. However, inflation in Germany—which makes up 30% of the euro zone's economy—has been rather lower than the average. So interest rates that are appropriate for the euro zone as a whole are too high for Germany. To aggravate matters, Germany has a much weaker banking system than the rest. Like Japan, it has too many unprofitable banks that need rationalising and restructuring. While this is being done, banks are reluctant to lend, so credit growth is stagnant. The pessimists about Europe say that the state of Germany's banks, its structural rigidities and its low inflation raise the spectre of Japan-style deflation that could sink the economic prospects of the entire euro zone. Do trains pull locomotives? Optimists about Europe—of whom there are a few—suggest that whereas the ECB may not have loosened interest rates enough for Germany, its cuts should be enough to get demand going again in the rest of the euro zone. Growth there, they argue, will eventually pull Germany along too. Analysts at Goldman Sachs, for instance, point out that real interest rates outside Germany are negative, and that the euro zone as a whole has a relatively healthy balance sheet and little spare capacity. They reckon the ECB's rate cuts so far will be enough to boost the growth in domestic demand in France from 1.1% this year to 3.1% next year and in Italy from 1.4% to 2.9%. Given Germany's weight in continental Europe, the idea of robust European growth without Germany seems a stretch. But whether the macroeconomic optimists or pessimists win the day depends in large part on what happens to the euro