(Repeat of item moved Sunday, Jan. 11)
By Emily Kaiser
WASHINGTON, Jan 12 (Reuters) - The European Central Bank may soon confirm what its counterparts in Britain and the United States have learned: cutting interest rates to the bone isn't enough to keep the economy from worsening.
When the ECB meets to set short-term borrowing costs on Thursday, it will have plenty of distressing economic data to support another interest rate reduction from the current level of 2.5 percent, the highest in the developed world.
The question is how much another cut would accomplish.
Even under normal circumstances, monetary policy takes time to filter through to the broader economy. In a credit crunch like this one, the impact is muted at best because banks are reluctant to lend, no matter how cheap the money gets.
That is a big reason why the United States, Britain, Canada, Mexico, China and a host of other countries are preparing large stimulus packages alongside aggressive interest rate reductions.
"We do need some sort of fiscal stimulus to back up the monetary policy," said Chas Roy-Chowdhury, head of taxation for the Association of Chartered Certified Accountants in London. "Without the two things going together, it's just not going to work."
But a fight is brewing in Europe over how best to boost growth without blowing up budgets, and the ECB's view on the debate will be closely watched this week.
Germany has so far committed to a 50 billion euro spending package, which some critics dismiss as too small, and pressure is growing on Europe's biggest economy to step up its recession-fighting efforts.
A majority of economists polled by Reuters think the ECB will lower rates by another half point this week, but perhaps just as important for the global economy is what ECB President Jean-Claude Trichet says about government spending.
He has stressed that European Union members should respect budget rules that limit deficits, a view that supports Germany's conservative approach. Last week, he said countries should use "all the room for maneuvering, but nothing but the room for maneuvering" in planning stimulus packages.
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Adam Posen, deputy director of the Peterson Institute for International Economics, said Germany was in danger of hamstringing the rest of Europe by doing too little.
As Europe's biggest economy and a vital part of global trade, Germany's recession response can have an out-sized effect on European and world growth.
"They use the word 'Keynesian' as a swear word," Posen said, referring to legendary economist John Maynard Keynes. "What they're doing right now looks like Japan circa the mid-1990s."
On Wednesday, British Prime Minister Gordon Brown and German Chancellor Angela Merkel are scheduled to meet in Berlin, and that may help to cool the dispute. Germany's finance minister has criticized Brown's plans to borrow billions of pounds to try to ease the recession.
Just as the Great Depression influences U.S. thinking to this day, many German policy-makers are haunted by the memory of hyper-inflation after World War One, and that has left them wary of big government spending, Roy-Chowdhury said.
But he said it was a mistake for Germany to tread softly now, and European budget rules should not be an obstacle in times of extreme crisis.
"We need to be very clear about why we are going to exceed those expenditure targets, and it is to stop a much worse recession," Roy-Chowdhury said.
As forecasts grow gloomier, Germany is likely to feel even more pressure to step up its commitment. A survey released on Saturday by the closely watched U.S. newsletter Blue Chip Economic Indicators showed that economists on average think Germany's economy will contract by 1.3 percent in 2009. A month earlier, the consensus was for a decline of 0.9 percent.
Economists also downgraded their views on the United States, Canada, Mexico, Japan, South Korea and Taiwan, among others. For the entire euro zone economy, they now see a 2009 contraction of 1.2 percent, compared with the 0.6 percent dip they forecast in December.
The worsening recession has already triggered a change of heart regarding spending and deficits in Canada. Prime Minister Stephen Harper, whose Conservative party has long fought against deficits, said on Friday that the budget he will unveil later this month will be one of the biggest in a long time.
"We're going to work on the assumption that this is going to be a tough time, that we should not underestimate the actions we need to take," he said. (Additional reporting by Louise Egan in Ottawa; Editing by Dan Grebler)