IF ONE had to tie together the Italian election with Moody's downgrade of Britain, the theme might be that the tide is turning against austerity. Indeed, Thursday's by-election in Eastleigh (a seat in southern England) showed the UK might have its own Beppe Grillo-style disrupting force in the form of the UK Independence Party. But the British downgrade showed that, for all its attempts to please the markets, slow growth in the UK is preventing the government from making a dent in its debt, while Italy showed that voters will eventually reject an austerity policy.

Indeed, this rather damning graph from Dhaval Joshi of BCA Research seems to indicate quite definitively that austerity is damaging economies. The vertical axis shows the growth in GDP per capita since the 2009 low; the horizontal axis, the cut in the structural fiscal deficit (ie the impact of deliberate government policy). There is a very strong and negative relationship which will delight Keynesians everywhere (or rather cause them to shake their heads in disgust).

That said, I think the graph is more relevant to policy decisions in the US and the UK than to, say, Greece. The latter could not continue to run big deficits because it could find no-one to buy its bonds; it has had to rely on official help from the rest of Europe. (The same applies to Portugal, which is the also in the south-west corner of the scatter chart). Non-eurozone members are quick to lecture the creditor nations that they should supply more aid (in the form of cheap loans) to southern Europe with fewer conditions. But it does make a difference when the debtors are not in your country; try asking Congress to fund the Mexican deficit on a long-term basis. The British government has been particularly sanctimonious in this regard. Another point worth noticing is that the UK has been more aggressive in the use of QE (26% of GDP) than the US (14%) of GDP and has achieved worse results in terms of growth. Of course, this might be down to its proximity to the euro-zone, but it does suggest that fiscal policy is more influential than monetary. And the UK's fiscal policy seems to have been misguided, as previous blog posts have suggested; capital spending has been slashed and taxes increased, while current spending has been rising. This week's leader suggests some ways policy should be refocused. Regardless of the economics, the politics of this are all very difficult, as this week's column started to explore. Lombard Street Research has just produced a very good note comparing Europe today with the situation in the 1920s and 1930s; the insistence of the Allies in demanding reparations from the Germans, compounded by the initial insistence of the Americans in treating inter-Allied debts as separate from the reparations issue, led to a debt crisis. This was made worse by a fixed currency mechanism (the gold standard) and the attempt to enforce austerity. The result was not just the Depression but the rejection by voters of mainstream parties.

So perhaps we will turn back to fiscal stimulus under the politicial imperative. Will this work? While the belief by some on the right that all government involvement in the economy is harmful seems antediluvian, they are surely right that there is some point at which government involvement becomes too great. The Reinhart/Rogoff rule (that economies slow once government debt passes 90% of GDP) may reflect this point; high debt ratios are a reflection of past deficits, past deficits reflect high government spending, and high spending reflects more government involvement in the economy. Our recent, very positive, special report on Scandinavia showed that Sweden had overdone the big government by the early 1990s and has reformed, and prospered, since then.

So here is another table from David Ranson of Wainwright Economics.

This shows the relationship between changes in federal spending and private sector spending, going back to 1929; the relationship is clearly inverse. Before you reach for the comment button, one point should be made clear;

transfer payments

(unemployment

benefits etc) are excluded

. So the obvious retort - that this graph merely shows the automatic stabilisers at work - cannot be made.

The idea that government should use the current climate of low rates to finance infrastructure projects that boost the long-term productive capacity of the economy makes a lot of sense, subject to the proviso that governments pick the right projects and manage them well. But one must also allow for the example of Greece; where a country has lived beyond its means for an extended period (by borrowing against future growth), there may be no way of avoiding a fall in living standards.