Robert Skidelsky and Nicolò Fraccaroli share some exclusive insights about their latest book, Austerity vs Stimulus.

The book sets out to answer whether the British government should have opted for stimulus or austerity in the response to the financial crisis. Where do you think we would be had the government opted for stimulus – what about Europe?

Austerity vs Stimulus presents two contrasting stories that answer your question: one that we can observe, the other that we cannot. The first is the ‘expansionary-austerity’ story, for which cutting public expenditure (fiscal contraction) during a crisis is the best measure for an economy to recover. This is the view that the Chancellor of the Exchequer George Osborne followed in 2010, and that we can therefore observe. Today, the UK’s GDP is growing again, but after a very slow recovery path with respect to other advanced economies. Moreover, growth came at a very high cost: public services have been slashed and still the public debt has increased. The other story is the one John Maynard Keynes told us in the 1930s: during a slump a fiscal stimulus is the right medicine. We can’t observe it since, as Keynes was left unheard by the Treasury at his times, contemporary Keynesian economists were also ignored during the crisis. But still, through historical experience and data, economists estimate that public investment would have increased British production further up. Today, institutions such as the Office for Budget Responsibility (OBR) and the International Monetary Fund (IMF) endorse this view, recognising that austerity was the wrong response for the UK.

Europe is a quite different matter since it’s composed of very different economies (e.g. Greece and Germany), with different fiscal policies, but a common monetary policy which is run by the ECB. This makes them intrinsically more vulnerable to market sentiments than the UK. Austerity was implemented in Europe in the belief that investors were worried about member states’ public debts, regardless of how they originated differently across Greece, Spain and Italy. Today, we know that despite the loss in GDP that austerity produced, financial actors did not seem to care about changes in the debt-to-GDP ratios, as they did not affect spreads (see De Grauwe and Ji 2013). In our book we explain that the reason for this lies on the particular nature of confidence, which has been quite overlooked by the literature. Taking confidence seriously would have changed economists’ predictions about the effect of austerity and stimulus, and probably also the policies that were implemented.

How did you go about framing the debate and selecting the contributors to the book?

Our main criteria in selecting the contributions were two. First, we wanted the reader to have a clear idea about what the arguments of both sides of the austerity vs stimulus debate are. Robert and I have quite a clear stand in this debate, so we let austerity supporters to speak about austerity. For example, in the book the expansionary austerity view is entirely presented by economists Alesina and Giavazzi, who were among the main creators and advocates of such theory. Secondly, we believe it’s fundamental that every citizen get acquainted about this debate, since it affects everyone’s life. For this reason, we made the language of the book as simple as possible, free of the complicated economics jargon or mathematical formulas, so that everyone can read this book, even those without a degree in economics. In spite of its simplicity, however, the book presents the arguments –together with their supporting charts and figures- in their original form, offering to more expert readers a useful compendium on the topic.

The book reprints an exciting feud between Economic Historian, Niall Fergusson and the Keynesians over the issue of the British Government’s austerity. What are your thoughts on the dispute now that some time has passed?

My first immediate thought is that this dispute is still extremely important to understand today’s events and where they are leading us, both from an economic and political point of view. Take Brexit: a paper by Becker et al. 2016 showed that in those areas of Britain where austerity was harsher, larger shares of people voted for leaving the EU (see also Wren-Lewis 2016). While Labour has changed its mind since 2015 General Elections, after some zig-zag the new Chancellor of the Exchequer seems now inclined to follow the contractionary policy of his predecessor. Understanding the debate over austerity and stimulus is therefore fundamental to grasp many of today’s economic events.

Regarding specifically the feud between Ferguson and Skidelsky, I think it helped to highlight a very important aspect, largely underestimated by many analysts: confidence, which is at the centre of our book as well as of this clash of ideas. Ferguson claimed austerity increased business confidence and therefore investment and growth, while Skidelsky and other Keynesians argued the opposite, namely that only with a fiscal stimulus can resurge confidence. The reason why confidence is so crucial is that it’s still an unknown beast for economists, who are not used to reason in a non-rational world. This setting made the acceptance of austerity ideas smoother. Today, however, there are many studies going in the direction of introducing ‘animal spirits’ in their model (see Barsky and Sims 2012, and Bachman and Sims 2012 for example, or behavioural macro models). Interestingly, they all agree on the positive effect of a fiscal stimulus on confidence during a slump, as Keynes suggested.

What do you think of the resurgence of economic nationalism? Do you think so-called ‘Trumpenomics’ fits easily into the Austerity or Stimulus categories?

I think economic nationalism and austerity are logically linked and ideologically unlinked. Let’s start with the ideology. They are both categories that belong to the traditional right-wing’s political narrative, and this might explain why we often see them together, like in Trumpenomics, where nationalist stances are combined with a $4.1 trillion cuts on spending proposal (ultimately rejected by the Congress). In one of the chapters of our book, Mark Blyth explains why we can talk of austerity as an ideology. Austerity has always been attractive to right-wing movements, as it is clearly linked to a reduction of the State (the public) in favour of (private) market forces. Still, the idea of expansionary austerity was so successful in the UK and Europe that we saw even centre-left parties embracing austerity during the crisis. The logical connection is quite worrisome. Cuts in public spending lead to poorer public services, and therefore higher economic inequality and political unrest. All this happened to take place contemporaneously to a huge migration wave from the Middle East to Europe. It was easy then for some right-wing vote-seekers to propose the catchy as well as false argument that poorer public services depended on the transfer of shares of such services to migrants, as the Front National in France, the UKIP in the UK and the Lega Nord in Italy argued.

Vince Cable’s contribution is about Keynesian Austerity, which almost seems like a contradiction. Do you think you could describe this for us?

Vince Cable, who at the time was Secretary of State for Business, Innovation and Skills of the Coalition Government, developed such theory to prove that Keynes would have supported the Coalition budget cuts. Keynesian Austerity rests on the belief that decisive spending cuts in the UK are the best tool to drive the perceived risk of a fiscal crisis away. By calming down the private sector, credit becomes easier and investment and savings are released. Austerity, therefore, is supposed to produce a ‘private Keynesian’ stimulus. This idea, that is nothing more than the expansionary austerity theory (mentioned above) applied to the UK, lies on the assumption that Great Britain’s risk of default isn’t in any way different from the risk run by Greece in 2010. This premise, however, is subject to many criticisms, that are exposed in the book. In the same chapter of Cable’s contribution, we’ve included a reply by David Blanchflower and Robert Skidelsky to the idea of Keynesian Austerity.