When Paul Krugman coined the term confidence fairy, he meant it as a pedantic critique of UK Prime Minister David Cameron’s austerity agenda. The cuts that were administered to the welfare systems were driven by a need to reduce the deficit – the existence of which hampered market confidence in Britain’s economy, or so was argued. Of course, Krugman attacked this logic through economics (some of which is disputed even by his supporters), implicitly making use of his Nobel Prize to substantiate his argument. But he was definitely on to something. Although not the first to do so, he was certainly the most important voice drawing our attention to the perpetual use of the word confidence to justify a political and economic policy – one with implications that have been felt across the world.

Many critics have come to understand that confidence is a word frequently and arbitrarily used in the media and policy-making circles to disguise an economic ideology. But these same individuals who perpetuate the idea that confidence is key to growth seem to lack a fundamental understanding of the complexity that the word entails. Moreover, they have simplified it to such an extent that it can be used flexibly to justify contentious political and economic policies that affect large segments of the population. As Krugman astutely noted, confidence (or lack thereof) is what has enabled David Cameron to rationalise the biggest cuts to the social welfare state in the UK since Margaret Thatcher; confidence is what drives European policy-makers to issue a crippling austerity agenda for southern Europe; and perhaps most cynically of all, with hardly a shred of economic wisdom, confidence is used as a term by the Republican party to undermine any attempts at resolving the jobs crisis by the Obama administration, justified or not.

The purpose of this article is to bring attention to the arbitrary use of the word confidence as a way to disguise an economic policy that is rarely based on facts or consensus. Masquerading a contentious and highly disputable theory behind a word has been done before with only post-facto scrutiny. The most famous in recent memory may be Terrorism; it was applied liberally to justify a whole range of policies that either directly undermined civil liberties, perpetuated a global war, or helped create an environment whereby fear of anything necessitates indiscriminate – often deadly – action. Confidence should be seen as no different from the word terrorism, other than the obvious definitional difference. As such, it should be scrutinised more heavily by the media and the academic world.

Economic confidence vs. Political confidence

Perhaps the most elementary criticism of the word confidence is its seemingly universal and indiscriminate use to explain purely economic forces. David Cameron says in a Davos World Economic Forum essay that continued deficit spending will hamper confidence in Britain’s economy. German Chancellor Angela Merkel says Greece’s inability to sustain growth is due to the decade of undisciplined spending by their governments. And, despite political leanings, President Obama increasingly discusses the confidence of bond markets and the need to keep them empowered. His recent interviews would seem to put him in the same camp as most Republicans and pro-austerity economists, much to the displeasure of voters and economists on the left.

This is problematic. There are various types of confidence that policy-makers needlessly gloss over. As it pertains to the global financial crisis, two of these types are crucial: Economic confidence, and political confidence.

Take, for example, the numerical “value” of measuring confidence. For the past five years, economists and proponents of austerity measures have warned that increased deficit spending will raise inflation to unsustainable levels, leading to a spike in interest rates that will negatively affect the economy. A sudden rise in long-term interest rates represents the market’s uncertainty in the ability of the government to repay its debt.

But this does not seem to be the case.

A careful look at the data seems to refute such logic. What is the current long-term interest rate of the US government? As close to zero as is possible.  What about Britain, which has a stubbornly higher level of public debt?  Similar story.  Indeed, Britain’s interest rates have almost always been relatively low, despite exceptionally high levels of public debt for nearly a century.  What about inflation?  It is currently below expectations in almost all of the OECD countries.

Source: Businessinsider.com

The irony is that the same individuals who argue about the need to keep markets confident in the economy are the same individuals who seem to be ignoring the market’s own opinion: that confidence in the US and the UK is quite strong, despite high levels of debt. By extension, it seems plausible to argue that deficit spending by either government is not as bad as it seems, because markets are confident in either government’s capacity to repay its debt in the long run. If politicians were indeed rational and not driven by dogmatic falsehoods, then a healthy round of fiscal stimulus might be used to help resolve the miserable unemployment crisis.

But what about Greece, Italy, Portugal, and Spain? The ‘GIPS’ (or as they are known colloquially in the EU, the ‘PIGS’) are suffering from very high interest rates, making borrowing increasingly difficult. It has been argued that their high rates of borrowing are directly related to the lack of confidence in their governments’ abilities to pay off their debts. Why then are markets so confident in the US or UK economies, and not the others?

This brings us back to the distinction between economic confidence and political confidence. What is the key difference in this context between the GIPS and the US or UK? Ignoring the obvious linguistic/cultural/societal answer, the difference is that the former lack their own central banks attached to a structured and institutionalised political framework. The US has the Federal Reserve Bank, while the UK has its Bank of England. Despite intending to remain ‘independent’, both are highly institutionalised within the governance mechanism of their respective political and economic systems, meaning that political expediency is written into their function. When the financial crisis hit and sovereign debt became the centerpiece of all economic analysis, these central banks mobilised to contain the problems as best they could through liberal fiscal and monetary policies. In other words, the Fed and BoE were in a perfect place, politically, to undertake their activities with effect. The European Central Bank (ECB), on the other hand, was handcuffed by its ideological priority, so to speak, of maintaining stable inflation and not guaranteeing the debts of the GIPS.

What does this mean for the idea of confidence? It suggests that political confidence is just as important as economic confidence, and that the two can be mutually exclusive. While the US/UK and the GIPS were both indebted governments, markets rewarded the former with low interest rates, while punishing the latter with high ones, largely because markets had faith in the political establishment of the governance mechanisms of the US and UK.

Critically, it also means that the EU’s focus on an austerity agenda is a misplaced policy: greater focus should be on creating a more stable fiscal environment whereby the ECB has the flexibility and the authority to engage in operations that will restore confidence in debtor nations’ economies. This necessarily means that the ECB would need the freedom to buy the debt of the GIPS and exercise a degree of fiscal and monetary authority that can directly contradict its stated purpose. In so doing, the abject crisis of confidence within the EU would hopefully be allayed.

Similarly, consider the cases of Greece and California. Both are governments highly indebted, and both are suffering from low, sometimes negative economic growth. Yet while Greece amounts to no more than 3% of Europe’s GDP, the state of California is the eighth largest economy in the world.  For most of the financial crisis, it was rated one of the top 10 governments likely to default. By some estimates, it was considered riskier than Latvia and Iraq, of all places. How come there is such little consideration in the media about the risk of California defaulting on its debts? Make no mistake: this scenario is entirely possible. The political situation is hardly desirable, even by Greek standards. A stubborn aspect of California’s democracy is the ability of the population to impose amendments, called propositions, to its state constitution. One of these gems was Prop. 13, which required a two- thirds majority in both legislative houses to amend taxes above their inflation value. What it effectively did was permanently remove any ability of the state legislature to raise revenue through taxes or stimulus. With an economy dependent on exports and global consumption, which were both down as a result of the financial crisis, its prospects for recovery looked slim. California, it seemed, was America’s Greece; should it fail, the national US economy would quickly follow it (yes, I concede that there are major differences between Greece and California that make a direct comparison problematic. However, the point is that market confidence pervades in both governments despite their structural differences).

Again, it indicates that there is much more confidence in the US (and by extension its 50 states, each with their own budget problems) because there is high confidence in the political institutions of the US government. Greece and its economic partners in southern Europe are suffering from an inflexible and hesitant EU governance system that holds ideological principles as more important than economic expediency.