Austerity

For other uses, see Austerity (disambiguation).

For the current opposition to present-day austerity measures, see Anti-austerity protests.

In economics, austerity describes policies used by governments to reduce budget deficits during adverse economic conditions. These policies can include spending cuts, tax increases, or a mixture of the two. Austerity policies may be attempts to demonstrate governments' liquidity to their creditors and credit rating agencies by bringing fiscal income closer to expenditure.

In macroeconomics, reducing government spending generally increases unemployment. This increases safety net spending and reduces tax revenues, to some extent. Government spending contributes to gross domestic product (GDP), so the debt-to-GDP ratio which signifies liquidity may not immediately improve. Short-term deficit spending particularly contributes to GDP growth when consumers and businesses are unwilling or unable to spend. Under the controversial theory of expansionary fiscal contraction (EFC), a major reduction in government spending can change future expectations about taxes and government spending, encouraging private consumption and resulting in overall economic expansion.

Initial austerity results in Europe have been as predicted by macroeconomics, with unemployment rising to record levels and debt to GDP ratios rising, despite reductions in budget deficits relative to GDP. Eurostat reported that Euro area (EA17) unemployment reached record levels in March 2013 at 12.1%, up from up from 11.0% in March 2012 and 10.3% in March 2011; and that the debt to GDP ratio for the 17 Euro area countries together was 70.1% in 2008, 80.0% in 2009, 85.4% in 2010, 87.3% in 2011 and 90.6% in 2012. Further, real GDP in the EA17 declined for six straight quarters from Q4 2011 to Q1 2013. The U.S. Congressional Budget Office estimated in August 2012 that if the U.S. implemented moderate austerity measures, the unemployment rate would rise by over 1% and economic growth would be significantly reduced in 2013. The U.S. partially avoided the "fiscal cliff" through the American Taxpayer Relief Act of 2012. U.S. unemployment has fallen steadily from a peak of 10% in early 2010 to 7.6% by March 2013.

Justifications

Austerity measures are typically taken if there is a threat that a government cannot honor its debt liabilities. Such a situation may arise if a government has borrowed in foreign currencies that they have no right to issue or if they have been legally forbidden from issuing their own currency. In such a situation, banks and investors may lose trust in a government's ability and/or willingness to pay and either refuse to roll over existing debts or demand extremely high interest rates. In such situations, inter-governmental institutions such as the International Monetary Fund (IMF) may demand austerity measures in exchange for functioning as a lender of last resort. When the IMF requires such a policy, the terms are known as 'IMF conditionalities'.

Austerity may also have moral and psychological roots, appealing to the belief that the excesses of a boom period should result in pain as part of a cleansing period, represented by higher taxes and reduced government spending. It may also appeal to the wealthier class of creditors, who prefer low inflation and the higher probability of payback on their government securities by less profligate governments.

In some cases, governments became highly indebted after assuming private debts following banking crises. For example, this occurred after Ireland assumed the debts of its private banking sector during the European sovereign debt crisis. This rescue of the private sector ironically resulted in calls to cut back the profligacy of the public sector.

Typical effects

Development projects, welfare, and other social spending are common programs that are targeted for cuts: Taxes, port and airport fees, train and bus fares are common sources of increased user fees. Retirement ages may be raised and government pensions reduced.

In many cases, austerity measures have been associated by critics with a decline in standard of living, and have led to popular protest. A representative example is the nation of Greece. The financial crisis—particularly the austerity package put forth by the EU and the IMF— was met with great anger by the Greek public, leading to riots and social unrest. On 27 June 2011, trade union organizations commenced a forty-eight hour labor strike in advance of a parliamentary vote on the austerity package, the first such strike since 1974. Massive demonstrations were organized throughout Greece, intended to pressure parliament members into voting against the package. The second set of austerity measures was approved on 29 June 2011, with 155 out of 300 members of parliament voting in favor. However, one United Nations official warned that the second package of austerity measures in Greece could pose a violation of human rights.

Around 2011, the IMF started issuing guidance suggesting that austerity could be harmful when applied without regard to an economy's underlying fundamentals. In 2013 they published a detailed analysis concluding that, "if financial markets focus on the short-term behavior of the debt ratio, or if country authorities engage in repeated rounds of tightening in an effort to get the debt ratio to converge to the official target," then austerity policies could slow or reverse economic growth and inhibit full employment. Keynesian economists and commentators such as Paul Krugman have suggested that this has in fact been occurring, with austerity yielding worse results in proportion to the extent to which it has been imposed.

Theoretical considerations

Keynesian viewpoint

Red: corporate profits after tax and inventory valuation adjustment. Blue: nonresidential fixed investment, both as fractions of U.S. GDP, 1989–2012.

John Maynard Keynes said in 1937: "The boom, not the slump, is the right time for austerity at the Treasury." Contemporary Keynesian economists argue that budget deficits are appropriate when an economy is in recession, to reduce unemployment and help spur GDP growth. Economist Paul Krugman explained that a government is not like a household. Across an economy, one person's spending is another person's income. If everyone is trying to reduce their spending, the economy can be trapped in what economists call the paradox of thrift, worsening the recession as GDP falls. If the private sector is unable or unwilling to consume at a level that increases GDP and employment sufficiently, he argued the government should be spending more.

In general, the level of economic output is set by business expenditure, but there is no reason to expect it to stabilize at full utilization of the economy's resources. High business profits do not necessarily lead to increased economic growth. When businesses and banks have disincentive to spend accumulated capital, such as cash repatriation taxes from profits in overseas tax havens and interest on excess reserves paid to banks, increased profits can lead to decreasing growth.

Economists Kenneth S. Rogoff and Carmen M. Reinhart wrote in April 2013: "Austerity seldom works without structural reforms — for example, changes in taxes, regulations and labor market policies — and if poorly designed, can disproportionately hit the poor and middle class. Our consistent advice has been to avoid withdrawing fiscal stimulus too quickly, a position identical to that of most mainstream economists." To help improve the U.S. economy, they advocated reductions in mortgage principal for underwater homes (i.e., where the value of the home is less than the mortgage principal) to help reduce private debts.

Multiplier effects

Different tax and spending choices of equal magnitude have different economic effects. For example, the U.S. Congressional Budget Office estimated that the payroll tax (levied on all workers earning a wage) has a higher multiplier (impact on GDP) than the income tax (which is levied primarily on wealthier workers). In other words, raising the payroll tax by $1 as part of an austerity strategy would slow the economy more than raising the income tax by $1, resulting in less net deficit reduction. In theory, it would stimulate the economy and reduce the deficit if the payroll tax were lowered and the income tax raised in equal amounts.

Crowding in or out

Further information: Crowding out (economics)

The term "crowding out" refers to the extent to which an increase in the budget deficit offsets spending in the private sector. Economist Laura D'Andrea Tyson wrote in June 2012: "By itself an increase in the deficit, either in the form of an increase in government spending or a reduction in taxes, causes an increase in demand. But how this affects output, employment and growth depends on what happens to interest rates. When the economy is operating near capacity, government borrowing to finance an increase in the deficit causes interest rates to rise. Higher interest rates reduce or “crowd out” private investment, and this reduces growth. The “crowding out” argument explains why large and sustained government deficits take a toll on growth; they reduce capital formation. But this argument rests on how government deficits affect interest rates, and the relationship between government deficits and interest rates varies. When there is considerable excess capacity, an increase in government borrowing to finance an increase in the deficit does not lead to higher interest rates and does not crowd out private investment. Instead, the higher demand resulting from the increase in the deficit bolsters employment and output directly, and the resulting increase in income and economic activity in turn encourages or 'crowds in' additional private spending. The crowding-in argument is the right one for current economic conditions."

Government budget balance as a sectoral component

Sectoral financial balances in U.S. economy 1990–2012. By definition, the three balances must net to zero. Since 2009, the U.S. capital surplus and private sector surplus have driven a government budget deficit.

U.S. savings and investment; savings less investment is the private sector financial surplus

According to economist Martin Wolf, the U.S. and many Eurozone countries experienced rapid increases in their budget deficits in the wake of the 2008 crisis as a result of significant private sector retrenchment and ongoing capital account surpluses. Policy choices had little to do with these deficit increases. This makes austerity measures highly counter-productive. Wolf explained that government fiscal balance is one of three major financial sectoral balances in a country's economy, the others being the foreign financial sector (capital account) and the private financial sector. The sum of the surpluses or deficits across these three sectors must be zero by definition. In the U.S. and many Eurozone countries other than Germany, a foreign financial surplus exists because capital is imported (net) to fund the trade deficit. Further, there is a private sector financial surplus due to household savings exceeding business investment. By definition, a government budget deficit must exist so all three net to zero. For example, the U.S. government budget deficit in 2011 was approximately 10% GDP (8.6% GDP of which was federal), offsetting a foreign financial surplus of 4% GDP and a private sector surplus of 6% GDP.

Wolf explained in July 2012 that the sudden shift in the private sector from deficit to surplus forced the U.S. government balance into deficit, writing: "The financial balance of the private sector shifted towards surplus by the almost unbelievable cumulative total of 11.2 per cent of gross domestic product between the third quarter of 2007 and the second quarter of 2009, which was when the financial deficit of US government (federal and state) reached its peak ... No fiscal policy changes explain the collapse into massive fiscal deficit between 2007 and 2009, because there was none of any importance. The collapse is explained by the massive shift of the private sector from financial deficit into surplus or, in other words, from boom to bust." Wolf also wrote that several European economies face the same scenario and that not deficit spending would likely have resulted in Depression. He argued that a private sector Depression (represented by the private and foreign sector surpluses) was being "contained" by government deficit spending.

Economist Paul Krugman also explained in December 2011 the causes of the sizable shift from private sector deficit to surplus in the U.S.: "This huge move into surplus reflects the end of the housing bubble, a sharp rise in household saving, and a slump in business investment due to lack of customers."

One reason austerity can be counterproductive in a downturn is due to a significant private sector financial surplus, in which consumer savings is not fully invested by businesses. In a healthy economy, private sector savings placed into the banking system by consumers is borrowed and invested by companies. However, if consumers have increased their savings but companies are not investing the money, a surplus develops. Business investment is one of the major components of GDP.

For example, a U.S. private sector financial deficit from 2004 to 2008 transitioned to a large surplus of savings over investment that exceeded $1 trillion by early 2009 and remained above $800 billion as of September 2012. Part of this investment reduction related to the housing market, a major component of investment. This surplus explains how even significant government deficit spending would not increase interest rates (because businesses still have access to ample savings if they choose to borrow and invest it, so interest rates are not bid upward) and how Federal Reserve action to increase the money supply does not result in inflation (because the economy is awash with savings with no place to go).

Economist Richard Koo described similar effects for several of the developed world economies in December 2011: "Today private sectors in the U.S., the U.K., Spain, and Ireland (but not Greece) are undergoing massive deleveraging [paying down debt rather than spending] in spite of record low interest rates. This means these countries are all in serious balance sheet recessions. The private sectors in Japan and Germany are not borrowing, either. With borrowers disappearing and banks reluctant to lend, it is no wonder that, after nearly three years of record low interest rates and massive liquidity injections, industrial economies are still doing so poorly. Flow of funds data for the U.S. show a massive shift away from borrowing to savings by the private sector since the housing bubble burst in 2007. The shift for the private sector as a whole represents over 9 percent of U.S. GDP at a time of zero interest rates. Moreover, this increase in private sector savings exceeds the increase in government borrowings (5.8 percent of GDP), which suggests that the government is not doing enough to offset private sector deleveraging."

Other views

Old-Keynesians, such as Alvin Hansen argued that government deficits provide the private sector both with new money for saving (the deficit) and a means to save (government interest-bearing bonds), increasing private sector wealth, and this wealth effect would reduce the need to save from current income. In their view, government debt enabled the private sector to continue consuming. It was therefore not a burden, at least when held domestically, but a necessity. This approach has interesting parallels with Richard Koo's recent concept of balance-sheet recession.

According to modern monetary theory, austerity measures by a national government are usually counterproductive because neither taxation nor bond issuance acts as a funding mechanism for the government. Instead all spending is done by crediting bank accounts, so national governments cannot run out of money unless they have fixed exchange rate to either foreign currency or gold or are part of a larger currency area like the eurozone where they do not have the right to issue money.

Austrian School economists argue that austerity measures do not necessarily increase or decrease economic growth. Rather, they argue that all attempts by central governments to prop up asset prices, bail out insolvent banks, or "stimulate" the economy with deficit spending make stable growth less likely.

Empirical considerations

Public Debt to GDP Ratio for Selected European Countries - 2008 to 2012. Source Data: Eurostat

A typical goal of austerity is to reduce the annual budget deficit without sacrificing growth. Over time, this may reduce the overall debt burden, often measured as the ratio of public debt to GDP.

Relationship between fiscal tightening (austerity) in Eurozone countries with their GDP growth rate, 2008–2012

Eurozone

During the European sovereign-debt crisis, many countries embarked on austerity programs, reducing their budget deficits relative to GDP from 2010 to 2011. For example, according to the CIA World Factbook Greece improved its budget deficit from 10.4% GDP in 2010 to 9.6% in 2011. Iceland, Italy, Ireland, Portugal, France, and Spain also improved their budget deficits from 2010 to 2011 relative to GDP. But the austerity policy of the Eurozone achieves not only the reduction of budget deficits. The goal of economic consolidation influences for example the future development of the European Social Model which unfolds already liberalisation tendencies in the Eurozone as a whole.

However, with the exception of Germany, each of these countries had public-debt-to-GDP ratios that increased (i.e., worsened) from 2010 to 2011, as indicated in the chart at right. Greece's public-debt-to-GDP ratio increased from 143% in 2010 to 165% in 2011. This indicates that despite improving budget deficits, GDP growth was not sufficient to support a decline (improvement) in the debt-to-GDP ratio for these countries during this period. Eurostat reported that the debt to GDP ratio for the 17 Euro area countries (EA17) together was 70.1% in 2008, 80.0% in 2009, 85.4% in 2010, 87.3% in 2011 and 90.6% in 2012. Further, real GDP in the EA17 declined for six straight quarters from Q4 2011 to Q1 2013.

Unemployment is another variable that might be considered in evaluating austerity measures. According to the CIA World Factbook, from 2010 to 2011, the unemployment rates in Spain, Greece, Ireland, Portugal, and the UK increased. France and Italy had no significant changes, while in Germany and Iceland the unemployment rate declined. Eurostat reported that Eurozone unemployment reached record levels in March 2013 at 12.1%, up from 11.6% in September 2012 and 10.3% in 2011. Unemployment varied significantly by country.

Economist Martin Wolf analyzed the relationship between cumulative GDP growth from 2008-2012 and total reduction in budget deficits due to austerity policies (see chart at right) in several European countries during April 2012. He concluded that: "In all, there is no evidence here that large fiscal contractions [budget deficit reductions] bring benefits to confidence and growth that offset the direct effects of the contractions. They bring exactly what one would expect: small contractions bring recessions and big contractions bring depressions." Changes in budget balances (deficits or surpluses) explained approximately 53% of the change in GDP, according to the equation derived from the IMF data used in his analysis.

Economist Paul Krugman analyzed the relationship between GDP and reduction in budget deficits for several European countries in April 2012 and concluded that austerity was slowing growth, similar to Martin Wolf. He also wrote: "... this also implies that 1 euro of austerity yields only about 0.4 euros of reduced deficit, even in the short run. No wonder, then, that the whole austerity enterprise is spiraling into disaster."

United States

U.S. discretionary spending, mandatory spending, and revenue increases over nine-year intervals

Another historical example of austerity was in the United States, which balanced its budget from 1998 to 2001. The basic strategy was to limit the rate of growth in defense and non-defense discretionary spending (which funds the major cabinet departments and agencies) during most of the 1990s, while growing revenues along with the economy. Comparing 1990 vs. 1999, defense and non-defense discretionary spending grew by a total of 14%, while revenues grew 77%. Public debt to GDP declined from 42.1% in 1990 to 39.4% by 1999, although it rose during the interim slightly. In contrast, from 2000 to 2009, discretionary spending grew by a total of 101% while revenues grew only 4%. Public debt to GDP increased from 34.7% in 2000 to 53.5% in 2009. Revenue grew nearly 25% when comparing 2000 to the pre-crisis peak in 2007, still considerably less than the prior decade.

United Kingdom

See also: United Kingdom government austerity programme

Britain had a negative result from its austerity policies, with the deficit remaining high despite spending cuts and the debt to GDP ratio rising. Before the May 2010 election, the UK economy appeared to be slowly recovering from the deep slump of 2008–09 that followed the global financial crisis.

Gordon Brown's Labour government had introduced a fiscal stimulus to help turn the economy around. GDP was growing at an annual rate of about 2.5%. Once cuts in spending started to be felt in Q4 2010, growth turned negative and a double-dip recession began that lasted into 2012. While GDP did expand in Q3 2012, the Office of Budget Responsibility (OBR) expects another decline in Q4 2012.

For 2013, the OBR is forecasting GDP growth of just 1.3%. With the economy so weak, the OBR says that the unemployment rate will rise from 8.0% to 8.2% in 2013. Back in 2009, the OBR predicted that by the end of 2013–2014, the deficit would be 3.5% GDP.

In December 2012, OBR projected that the actual figure will be 6.1% GDP. The debt-to-GDP ratio, which was expected to peak at 70%, hit 75% in 2012, and is forecast to climb to 80% in 2015–2016.

France

In April and May, 2012, France held a presidential election in which the winner François Hollande had opposed austerity measures, promising to eliminate France's budget deficit by 2017 by canceling recently enacted tax cuts and exemptions for the wealthy, raising the top tax bracket rate to 75% on incomes over a million euros, restoring the retirement age to 60 with a full pension for those who have worked 42 years, restoring 60,000 jobs recently cut from public education, regulating rent increases; and building additional public housing for the poor. In June, Hollande's Socialist Party won a supermajority in legislative elections capable of amending the French Constitution and enabling the immediate enactment of the promised reforms. French government bond interest rates fell 30% to record lows, less than 50 basis points above German government bond rates.

Latvia

Latvia's economy returned to growth in 2011 and 2012 outpacing the 27 nations in the EU, while implementing significant austerity measures. Advocates of austerity argue Latvia represents an empirical example of the benefits of austerity, while critics argue austerity created unnecessary hardship.

According to the CIA World Fact Book: "Latvia's economy experienced GDP growth of more than 10% per year during 2006–07, but entered a severe recession in 2008 as a result of an unsustainable current account deficit and large debt exposure amid the softening world economy. Triggered by the collapse of the second largest bank, GDP plunged 18% in 2009. The economy has not returned to pre-crisis levels despite strong growth, especially in the export sector in 2011–12. The IMF, EU, and other international donors provided substantial financial assistance to Latvia as part of an agreement to defend the currency's peg to the euro in exchange for the government's commitment to stringent austerity measures. The IMF/EU program successfully concluded in December 2011. The government of Prime Minister Valdis Dombrovskis remained committed to fiscal prudence and reducing the fiscal deficit from 7.7% of GDP in 2010, to 2.7% of GDP in 2012." CIA estimated that Latvia's GDP declined by 0.3% in 2010, then grew by 5.5% in 2011 and 4.5% in 2012. Unemployment was 12.8% in 2011 and rose to 14.3% in 2012. Latvia's currency, the Lati, fell from $.47 per U.S. dollar in 2008 to $.55 in 2012, a decline of 17%. Latvia plans to enter the euro zone in 2014. Latvia's trade deficit improved from over 20% GDP in 2006 to 2007 to under 2% GDP by 2012.

Eighteen months after harsh austerity measures were enacted (including both spending cuts and tax increases), economic growth began to return, although unemployment remained above pre-crisis levels. Latvian exports have skyrocketed and both the trade deficit and budget deficit have decreased dramatically. More than a third of government positions were eliminated, and the rest received sharp pay cuts. Exports increased after the price of goods was reduced due to private business lowering wages in tandem with the government.

Paul Krugman wrote in January 2013 that Latvia had yet to regain its pre-crisis level of employment. He also wrote: "So we're looking at a Depression-level slump, and 5 years later only a partial bounceback; unemployment is down but still very high, and the decline has a lot to do with emigration. It's not what you'd call a triumphant success story, any more than the partial US recovery from 1933 to 1936 — which was actually considerably more impressive — represented a huge victory over the Depression. And it's in no sense a refutation of Keynesianism, either. Even in Keynesian models, a small open economy can, in the long run, restore full employment through deflation and internal devaluation; the point, however, is that it involves many years of suffering ..."

Latvian Prime Minister Valdis Dombrovskis defended his policies in a television interview, stating that Krugman refused to admit his error in predicting that Latvia's austerity policy would fail. Krugman had written a blog post in December 2008 entitled: "Why Latvia is the New Argentina" in which Krugman argued for Latvia to devalue its currency as an alternative or in addition to austerity.

Controversy

100,000 peaceful anti-austerity protesters in front of the parliament of Greece on 29 June 2011.

Main article: Anti-austerity protests

Austerity programs can be controversial. In the Overseas Development Institute briefing paper "The IMF and the Third World" the ODI addresses five major complaints against the IMF's austerity 'conditionalities'. These complaints include these measures being "anti-developmental", "self-defeating", and "they tend to have an adverse impact on the poorest segments of the population". In many situations, austerity programs are implemented by countries that were previously under dictatorial regimes, leading to criticism that the citizens are forced to repay the debts of their oppressors.

Economist Richard D. Wolff has stated that instead of cutting government programs and raising taxes, austerity should be attained by collecting (taxes) from non-profit multinational corporations, churches, and private tax-exempt institutions such as universities, which currently pay no taxes at all.

In 2009, 2010, and 2011, workers and students in Greece and other European countries demonstrated against cuts to pensions, public services and education spending as a result of government austerity measures. Following the announcement of plans to introduce austerity measures in Greece, massive demonstrations were witnessed throughout the country, aimed at pressing parliamentarians to vote against the austerity package. In Athens alone 19 arrests were made while 46 civilians and 38 policemen had been injured by 29 June 2011. The third round austerity has been approved by the Greece parliament on 12 February 2012 and has met strong opposition especially in the cities of Athens and Thessaloniki where police clashed with demonstrators.

Opponents argue that austerity measures depress economic growth, and ultimately cause reduced tax revenues that outweigh the benefits of reduced public spending. This is especially the case when austerity measures affect the private sector and do not merely correct unreasonable expenditures on the public sector workforce. The case of Greece significantly corroborates these views^{[citation needed]}. Moreover, in countries with already anemic economic growth, austerity can engender deflation which inflates existing debt. Such austerity packages can also cause the country to fall into a liquidity trap, causing credit markets to freeze up and unemployment to increase. Opponents point to cases in Ireland and Spain in which austerity measures instituted in response to financial crises in 2009 proved ineffective in combating public debt, and placing those countries at risk of defaulting in late 2010.

In October 2012, the International Monetary Fund announced that its forecasts for countries which implemented austerity programs have been consistently overoptimistic, suggesting that tax hikes and spending cuts have been doing more damage than expected, and countries which implemented fiscal stimulus, such as Germany and Austria, did better than expected. This data has been scrutinized by the Financial Times, which found no significant trends when outliers like Germany and Greece are excluded. Determining the multipliers used in the research to achieve the results found by the IMF were also described as an "exercise in futility" by Professor Carlos Vegh of the University of Michigan. Also, Barry Eichengreen of UC Berkeley and Kevin H O'Rourke of Oxford write that the IMF's new estimate of the extent to which austerity restricts growth was much lower than historical data suggests.

Austerity sequence

Further information: Household debt

Several economists have argued that an appropriate strategy when an economy is faced with unusually high private debt levels is to exchange private debts for public debts initially, then cut government debt via an austerity strategy once the economy recovers. Applying an austerity strategy to a struggling economy can be counter-productive according to Keynesian theory described above.

For example, the private sector may become highly indebted, such as when a housing bubble bursts. Housing prices fall while the mortgage obligations remain fixed, leading to "underwater" homeowners unable to consume at sufficient levels to drive economic growth. A banking crisis can result, as defaulting homeowners result in banks unable to lend or stay in business, which slows the economy and worsens unemployment. These effects can become self-reinforcing, creating a downward economic spiral. This spiral is at the core of the subprime mortgage crisis in the U.S. and the European sovereign debt crisis.

Economist Amir Sufi at the University of Chicago argued in July 2011 that a high level of household debt was holding back the U.S. economy. Households focused on paying down private debt are not able to consume at historical levels. He advocated mortgage write-downs and other debt-related solutions to re-invigorate the economy when household debt levels are exceptionally high.

Economists Joseph Stiglitz and Mark Zandi both advocated significant mortgage refinancing or write-downs during August 2012. This could be financed by the government taking on additional debt in the short-run as a form of stimulus. The government would borrow at a very low interest rate and create an entity to purchase mortgages, receiving a higher interest rate from mortgages it refinances. Losses due to mortgage principal write-downs would be shared between the government and financial institutions, with the government losses offset by the interest rate differential.

The International Monetary Fund (IMF) reported in April 2012: "Household debt soared in the years leading up to the Great Recession. In advanced economies, during the five years preceding 2007, the ratio of household debt to income rose by an average of 39 percentage points, to 138 percent. In Denmark, Iceland, Ireland, the Netherlands, and Norway, debt peaked at more than 200 percent of household income. A surge in household debt to historic highs also occurred in emerging economies such as Estonia, Hungary, Latvia, and Lithuania. The concurrent boom in both house prices and the stock market meant that household debt relative to assets held broadly stable, which masked households' growing exposure to a sharp fall in asset prices. When house prices declined, ushering in the global financial crisis, many households saw their wealth shrink relative to their debt, and, with less income and more unemployment, found it harder to meet mortgage payments. By the end of 2011, real house prices had fallen from their peak by about 41% in Ireland, 29% in Iceland, 23% in Spain and the United States, and 21% in Denmark. Household defaults, underwater mortgages (where the loan balance exceeds the house value), foreclosures, and fire sales are now endemic to a number of economies. Household deleveraging by paying off debts or defaulting on them has begun in some countries. It has been most pronounced in the United States, where about two-thirds of the debt reduction reflects defaults." These countries might also benefit from household debt reduction policies involving exchanging private debt for public debt.

Balancing stimulus and austerity

Strategies that involve short-term stimulus with longer-term austerity are not mutually exclusive. Steps can be taken in the present that will reduce future spending, such as "bending the curve" on pensions by reducing cost of living adjustments or raising the retirement age for younger members of the population, while at the same time creating short-term spending or tax cut programs to stimulate the economy to create jobs.

IMF managing director Christine Lagarde wrote in August 2011: "For the advanced economies, there is an unmistakable need to restore fiscal sustainability through credible consolidation plans. At the same time we know that slamming on the brakes too quickly will hurt the recovery and worsen job prospects. So fiscal adjustment must resolve the conundrum of being neither too fast nor too slow. Shaping a Goldilocks fiscal consolidation is all about timing. What is needed is a dual focus on medium-term consolidation and short-term support for growth. That may sound contradictory, but the two are mutually reinforcing. Decisions on future consolidation, tackling the issues that will bring sustained fiscal improvement, create space in the near term for policies that support growth."

Federal Reserve Chair Ben Bernanke wrote in September 2011: "...the two goals--achieving fiscal sustainability, which is the result of responsible policies set in place for the longer term, and avoiding creation of fiscal headwinds for the recovery--are not incompatible. Acting now to put in place a credible plan for reducing future deficits over the long term, while being attentive to the implications of fiscal choices for the recovery in the near term, can help serve both objectives."

The "Age of Austerity"

The term "Age of austerity" was popularized by British Conservative leader David Cameron in his keynote speech to the Conservative party forum in Cheltenham on 26 April 2009, when he committed to put an end to what he called years of excessive government spending.

Word of the year

Merriam-Webster's Dictionary named the word "austerity" as its "Word of the Year" for 2010 because of the number of web searches this word generated that year. According to the president and publisher of the dictionary, "austerity had more than 250,000 searches on the dictionary's free online [website] tool" and the spike in searches "came with more coverage of the debt crisis".

Examples of austerity

• United States, 1921, 1937, 1946
• European Countries 2012
• Argentina, 1952
• Puerto Rico, 2009–2012
• Brazil, 2003–2006
• Netherlands, 1982–1990, 2003–2006, 2011-2014
• Germany, 2011
• United Kingdom, during and after the two World Wars, 2011–2014
• Czech Republic, 2010
• Italy, 2011–2013
• Greece, 2010–2012
• Ireland, 2010-2013
• Portugal, 2010–2011
• Romania, Ceaușescu's 1981-1989 austerity, 2010
• Japan, 2010 1949 American Occupation
• Spain, 1979, 2010
• Latvia, 2009
• Palestinian Authority, 2006
• Nicaragua, 1997
• Canada, 1994
• Cuba, 1991
• Mexico, 1985
• Israel, 1949–1959

See also

• Functional finance
• Paradox of thrift
• Planned shrinkage

External links

• The Austerity Zone: Life in the New Europe – videos by The New York Times
• Video: Richard Koo debates Kenneth Rogoff about the need for austerity, Institute for New Economic Thinking inaugural conference, 22 April 2010
• Socialist Studies Special Edition on Austerity (2011)
• Panic-driven austerity in the Eurozone and its implications Paul De Grauwe, Yuemei Ji, 21 February 2013
• NYT Review of Books - Paul Krugman - How the Case for Austerity Has Crumbled - June 2013
• IMF Working Paper-Olivier Blanchard and Daniel Leigh-Growth Forecast Errors and Fiscal Multipliers-January 2013