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By Noah Barkin

BERLIN (Reuters) - German Finance Minister Wolfgang Schaeuble put on a brave face at the end of IMF meetings in Washington this weekend, dismissing suggestions that Berlin had come under pressure to shift its economic course as spin doctoring .

But the reality is that Germany hasn t looked this isolated over its policy prescriptions for Europe since the height of the euro zone financial crisis more than two years ago.

In Washington, Schaeuble not only endured lectures from longtime critics such as Larry Summers, the former U.S. Treasury Secretary who in an unusually frank panel discussion accused Germany of leading Europe down a path of Japanese-style deflation with a misguided focus on budget consolidation.

He also had to listen to advice from traditional allies such as Finland s Jyrki Katainen, a future vice president of the European Commission, who warned that Germany could not remain strong forever if it failed to invest more in its own infrastructure and education system.

The criticism did not go unnoticed in Germany, where the media has so far been supportive of Berlin s drive for a balanced budget, its rejection of stimulus and its insistence that partners such as France and Italy press ahead with painful structural reforms despite slowing economies.

In its lead editorial on Sunday, conservative newspaper Die Welt argued that a weakening German economy should force a policy rethink and warned that Schaeuble s push to achieve a schwarze Null - a federal budget that is in the black - in 2015 should not turn into a mindless fetish .

The Sueddeutsche Zeitung suggested Chancellor Angela Merkel s Christian Democrats (CDU) risked turning into the Tea Party of Europe with their single-minded focus on deficit reduction.

Guntram Wolff, head of the Brussels-based Bruegel think tank, said he believed the economic case for running a small deficit in Germany was very compelling , although he played down the prospects of Berlin abandoning its balanced budget goal in a public way anytime soon.

I do think the political preference for a balanced budget will become weaker as the economy deteriorates, but the shift will happen in a silent way, he told Reuters.

VERY SUBSTANTIAL ERROR

Back in February, when Merkel s new grand coalition government presented a report on the economic outlook for 2014, it described Germany as being in the midst of a stable, broad-based recovery . Gross domestic product (GDP) was forecast to rise by 1.8 percent this year and by 2.0 percent next.

Since then, weakness in key euro area trading partners has begun hitting German exports and a deepening Ukraine crisis has unnerved businesses, which are postponing investments.

Last week, manufacturing orders, industrial output and exports in quick succession suffered their steepest one-month falls since early 2009, when the German economy was reeling from the after-effects of the Lehman Brothers bankruptcy and entering its deepest recession of the post-war era.

No one expects such a precipitous fall this time. But after a 0.2 percent contraction in the second quarter, Germany risks falling into a technical recession in the third quarter.

If the weakness continues into the final months of the year, the government s ambitious budget goal will look even more out of touch with economic reality, and the pressure to loosen the purse strings and invest more public money will grow. This week, Berlin is expected to cut its growth forecasts for this year and next to 1.2 percent.

In Washington, International Monetary Fund chief Christine Lagarde and European Central Bank president Mario Draghi were relatively polite in nudging Germany to adopt a more flexible approach, while Summers was typically blunt.

What s happening in Europe is not working, he said, sitting alongside a frowning Schaeuble. The monolithic focus on the financial deficit to the exclusion of the investment deficit, which causes a growth deficit, has been a very substantial error.

Schaeuble responded that writing checks was no way to boost the European economy. He rejected the idea that Germany was headed towards recession and put the onus firmly on France and Italy, urging them to press ahead with long overdue reforms.

Until now, Schaeuble and Merkel have spoken only about the need to encourage more private investment, for example by cutting red tape for businesses.

This has also been the focus of a panel of experts set up by Economy Minister Sigmar Gabriel, which is due to meet for a second brainstorming session later this month.

But over the weekend, Ulrich Grillo, the influential president of Germany s BDI industry federation, joined the sceptics in Washington in pressing Merkel to go further and present an action plan for public investment.

Only then will the private investors follow, Grillo said.

(Additional reporting by Krista Hughes in Washington; Writing by Noah Barkin; Editing by Gareth Jones)


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