Austerity

For other uses, see Austerity (disambiguation).

In economics, austerity is when a government reduces its spending and/or increases user fees to pay back creditors. Austerity is usually required when a government's fiscal deficit spending is felt to be unsustainable.

Reasons for taking austerity measures

Austerity measures are typically taken after a government's bond rating is downgraded, making it more expensive to borrow money. Government bonds are typically downgraded when debt grows substantially as a portion of GDP. Government debt grows as spending exceeds tax revenue. Such excess occurs when tax rates are such that revenues are kept low while government spending is increased. Such excess can also occur when the economic activity stagnates or decreases, such as in a recession, thereby reducing the government's tax revenue.

Banks, or inter-governmental institutions such as the International Monetary Fund (IMF), may require that an indebted government pursue an 'austerity policy'. This typically occurs when the government must refinance loans that are about to come due, for which the government cannot pay. The government may be asked to stop issuing subsidies or to otherwise reduce public spending. When the IMF requires such a policy, the terms are known as 'IMF conditionalities'.

Typical effects

Development projects, welfare, and other social spending are common programs of spending for cuts. Taxes, port and airport fees and train and bus fares are common sources of increased user fees.

In many cases, austerity measures have been associated with short-term declines in standard of living until economic conditions improved and fiscal balance was achieved.

Theoretical considerations

Contemporary mainstream economists consider macro policy in dynamic stochastic general equilibrium framework, where fiscal policy is discussed within an optimal taxation framework that assumes a representative agent is optimizing over a long-term horizon. The intuition behind such models is that the effect of any government deficit is mitigated by compensatory changes in the representative agent's spending decisions. This occurs because the agent will be responsible for paying off that deficit in the future. Thus, in a modern mainstream macroeconomists point of view, reducing government deficit allows the private sector to consume more and support the economy.

Old-Keynesians, such as Alvin Hansen had totally opposite view: they argued that government deficits provide private sector both with new money for saving (the deficit) and means to save to (government interest-bearing bonds), increasing private sector wealth and this wealth effect would reduce need to save from current income. Government debt enabled, in their view, private sector to continue consuming. It was therefore not a burden, at least when hold domestically, but a necessity.

Chartalist school argues that money is a creature of state and must be controlled, and that government intervention is needed to recycle excess savings to productive use in the economy.

Controversy

Austerity programs are frequently controversial, as they have an 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.

Examples of austerity

• Israel, 1949–1959
• United Kingdom, during and after the two World Wars
• Argentina, 1952
• Spain, 1979
• Mexico, 1985
• Cuba, 1991
• Nicaragua, 1997
• Palestinian Authority, 2006
• Latvia, 2009
• Greece, 2010
• United States, AZ, CA possible 2010

See also

• Functional finance

External links

• What about austerity?, The Boston Globe