Over the past few weeks, the world’s public debt crisis,simmering for months, has come to the boil. When the problems were confined tosmall countries such as Greece and Ireland, it was assumed that any falloutcould be contained. Now, however, the crisis has threatened to engulf nearlyeveryone. The high-wireconfrontation over the debt ceiling in the U.S. Congress raised theprospect of a default by the world’s biggest borrower. At the same time, themarkets turnedtheir attention to Italy,the eurozone’s third-largest economy and the world’s fourth-biggest debtor,threatening to raise its borrowing costs to unaffordable levels, or even to cutoff its access to funds. The two crises differed in many ways — not least inthat America’s borrowing costs fell while Italy’s rose — but the outcomes weresimilar in one respect: both countries have enacted plans to sharply cut theirbudget deficits. How different it seems from two years ago. In the wake ofthe 2008 financial crisis, the ideas of John Maynard Keynes, the early 20th centuryBritish economist who came to fame during the Great Depression, reignedsupreme. It was almost universally accepted that his prescription of massivedoses of deficit spending constituted the only possible cure for the global economiccollapse. But although large-scalegovernment stimulus programs averted economic catastrophe, apparentlyjustifying Keynes’s theories, it now seems that the Keynesian plan to rescuethe global economy is being left half-baked. His ideas are being abandoned eventhough unemployment remains far above pre-crisis levels and the economicrecovery is stalling. Keynesian economists and politicians may describetheir austerity-minded opponents asturkeys voting for Christmas, but they appear to be losing the battle.Is this just a moment of collective folly, a wilfulblindness to the lessons of the past? To Keynesians, after all, the historicalrecord is clear. Misguided attempts to balance the budget in the wake of the1929 crash turned a nasty recession into the Great Depression. It was only whenthe government started to run a substantial deficit from 1932 onwards that theslump abated and the economy recovered, aided by President Franklin D. Roosevelt’sdevaluation of the dollar in 1933. But the recovery was aborted whileunemployment was still high, as a result of the premature withdrawal of fiscaland monetary stimulus in 1937. A sharp and unnecessary second recessionfollowed in 1938, and full employment was only restored by the massiveadditional stimulus provided by war spending, after which Keynesian economicdoctrines produced a period of almost uninterrupted growth that lasted untilthe 1970s.The recession of 1938 is a pivotal event in this historicalnarrative, because it seems to parallel so closely the present situation. Byattempting to balance the budget before the economic recovery is fully established,the West risks a double-dip recession, just as occurred in the 1930s.Yet this story is not quite as simple as Keynesians wouldlike to think — and the events of 1938 are not the only historical examplethat can be brought to bear on current events. If Keynesians can point to theimpact of wartime spending on the economy, austerity advocates can point to theretreat from it, after both world wars. In 1918 and 1945, both the United States and Britain found themselves with veryhigh public debts and economies that had been artificially boosted during thewar as a result of deficit spending and loose monetary policies. Their averagebudget deficit in the last year of war was 25 percent of gross domestic product(GDP). Yet within two years after the end of the wars, both countries had returnednot just to sustainable levels of deficit, but to surplus. This was a fargreater level of fiscal tightening than anything contemplated nowadays, and itwas achieved exclusively through spending reductions. The outcomes of these post-war retrenchments areinstructive. In three out of the four cases of British and American post-waradjustment, the economies initially shrunk, but then started a period of strongand sustained growth with low unemployment. (The exception is Britain after World War I, which entered adecade-long economic depression in many ways as severe as America’s inthe 1930s. The difference here is in monetary policy: While the United Statescountered post-war inflation with interest rate hikes that brought prices backto 1919 levels but no lower, Britain made a concerted attempt to deflate pricesto pre-war levels so as to get back onto the gold standard at the old parity.In other words, it attempted an "internal devaluation" like the one now beingprescribed for the uncompetitive peripheral countries of the eurozone — andthe result was disastrous.) The post-war experience appears to offer some comfort for Americaand Britain– if not for the eurozone. It seems that even extreme fiscal contractions canbe pursued without long-term harm as long as monetary policy is left easy anddeflation is avoided. After the wars there was an inevitable period ofdifficult adjustment as the economy underwent a change in focus, reducing itsdependence on military spending. But once that adjustment was endured,economies rebounded rapidly. This was all the more remarkable because between them, theAllies comprised close to half of the world’s GDP, so there was no hope ofexporting to some "consumer of last resort."