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Stagnating Eurozone Seeks to Persuade Germany to Shift

Germany's Chancellor Angela Merkel (R) and France's President Francois Hollande arrive for a working session during an EU summit in Brussels, Oct. 24, 2014.

Eurozone leaders sought on Friday to bridge stark differences over how to avoid economic stagnation and deflation in the bloc, with Germany facing fresh calls to soften its budget rigor and spend more.

With a U.S.-style bond-buying plan by the European Central Bank off the table for now, the bloc has few options, leaving other eurozone leaders to tread a careful line between the opposing growth and austerity camps.

“It's very important to find a balance between growth and stability,” Finland's Prime Minister Alex Stubb said as he arrived at the second day of an EU summit at which ECB President Mario Draghi will address leaders.

After the eurozone's revival came to a halt in the second quarter, France and Italy want to shift course away from the spending cuts that marked the bloc's response to 2009-2012 crisis, but Germany says debt discipline must continue.

The eurozone's poor performance is becoming a wider concern, with the United States and the International Monetary Fund worrying that the bloc that makes up a fifth of the world economy is a drag on global prosperity.

The debate is complicated by EU rules that seek to keep country's public finances in order and Germany's promise to balance its books next year for the first time since 1969.

The European Union's top economic official renewed the charge against Berlin, saying that without investment the future was bleak for Europe's biggest economy, even if it is stronger than most.

“All euro area countries have shortages in potential growth, including Germany,” said Jyrki Katainen, the European Commissioner who will become the bloc's growth tsar from November, tasked with bringing down near record unemployment and sinking investment.

“Germany's potential growth is currently 1.5 [percent]. This is far too low,” he told reporters.

Grand bargain?

Diplomats say the eurozone may be moving towards a bargain where France and Italy, the second and third biggest eurozone economies, make new commitments to reform in return for more spending room in their budgets.

Italian Prime Minister Matteo Renzi is proposing tax cuts to get households spending again, as his country is suffering its third recession since 2008.

Jeroen Dijsselbloem, who chairs the meetings of eurozone finance ministers, said that reforms were key.

“Paris and in Rome are quite ambitious in terms of reforms and modernizing their societies, the government and the economy,” Dijsselbloem said. “I think that's crucial.”

The European Commission, which acts as a budget policeman for the eurozone, has until next Wednesday to reject any 2015 budgets with France's in the spotlight.

Even if it does so, changes made by Paris and Rome are likely to be small, officials say.

“We need to look at each case separately, keeping in view the Stability and Growth Pact rules and the need to maintain a responsible fiscal policy,” said Lithuanian President Dalia Grybauskaite, whose country joins the eurozone next year.

“Austerity needs to be in place, and in parallel we need to invest,” she said.

Such declarations on budget discipline could provide cover for the ECB to do more to fend off the deflation that would make it even harder for the eurozone to bring down its debts.

Many investors want to see the ECB launch a U.S.-style sovereign-bond buying program that could act as a proxy for a government stimulus. But Draghi faces resistance from some, notably Germany, because the eurozone is banned from directly financing governments.