In economic policy, austerity is a set of political-economic policies that aim to reduce government budget deficits through spending cuts, tax increases, or a combination of both.[1][2][3] There are three primary types of austerity measures: higher taxes to fund spending, raising taxes while cutting spending, and lower taxes and lower government spending.[4] Austerity measures are often used by governments that find it difficult to borrow or meet their existing obligations to pay back loans. The measures are meant to reduce the budget deficit by bringing government revenues closer to expenditures. Proponents of these measures state that this reduces the amount of borrowing required and may also demonstrate a government's fiscal discipline to creditors and credit rating agencies and make borrowing easier and cheaper as a result.
In most macroeconomic models, austerity policies which reduce government spending lead to increased unemployment in the short term.[5][6] These reductions in employment usually occur directly in the public sector and indirectly in the private sector. Where austerity policies are enacted using tax increases, these can reduce consumption by cutting household disposable income. Reduced government spending can reduce gross domestic product (GDP) growth in the short term as government expenditure is itself a component of GDP. In the longer term, reduced government spending can reduce GDP growth if, for example, cuts to education spending leave a country's workforce less able to do high-skilled jobs or if cuts to infrastructure investment impose greater costs on business than they saved through lower taxes. In both cases, if reduced government spending leads to reduced GDP growth, austerity may lead to a higher debt-to-GDP ratio than the alternative of the government running a higher budget deficit. In the aftermath of the Great Recession, austerity measures in many European countries were followed by rising unemployment and slower GDP growth. The result was increased debt-to-GDP ratios despite reductions in budget deficits.[7]
Theoretically in some cases, particularly when the output gap is low, austerity can have the opposite effect and stimulate economic growth. For example, when an economy is operating at or near capacity, higher short-term deficit spending (stimulus) can cause interest rates to rise, resulting in a reduction in private investment, which in turn reduces economic growth. Where there is excess capacity, the stimulus can result in an increase in employment and output.[8][9] Alberto Alesina, Carlo Favero, and Francesco Giavazzi argue that austerity can be expansionary in situations where government reduction in spending is offset by greater increases in aggregate demand (private consumption, private investment, and exports).[10]
^"Austerity measure". Financial Times Lexicon. Archived from the original on 22 March 2013. Retrieved 1 March 2013.
^Traynor, Ian; Katie Allen (11 June 2010). "Austerity Europe: who faces the cuts". London: Guardian News. Retrieved 29 September 2010.
^Wesbury, Brian S.; Robert Stein (26 July 2010). "Government Austerity: The Good, Bad And Ugly". Forbes. Archived from the original on 29 September 2010. Retrieved 29 September 2010.
^Hayes, Adam (4 March 2021). "Austerity". Investopedia. Retrieved 9 April 2021.
^"Austerity – Pros and Cons". Economics Help. 5 February 2020.
^"What is austerity?". The Economist.
^Storm, Servaas (3 July 2019). "Lost in Deflation: Why Italy's Woes Are a Warning to the Whole Eurozone". International Journal of Political Economy. 48 (3): 195–237. doi:10.1080/08911916.2019.1655943. ISSN 0891-1916.
^Krugman, Paul (15 April 2012). "Europe's Economic Suicide". The New York Times.
^Laura D'Andrea Tyson (1 June 2012). "Confusion about the Deficit". The New York Times. Retrieved 16 May 2013.
^Alesina, Alberto; Favero, Carlo; Giavazzi, Francesco (2019). Austerity: When It Works and When It Doesn't. Princeton University Press. p. 5. ISBN 978-0-691-17221-7. JSTOR j.ctvc77f4b.
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