Austerity became a popular term after the European sovereign debt crisis. In fact, it was named Marriam-Webster's word of the year in 2010. With debt levels unacceptably high, many countries were forced to make dramatic cuts to avoid default. These acts of deficit cutting, reduced spending and slashed public services are collectively known as austerity measures.
Effects of Austerity Measures
Austerity measures have a number of different effects on a country, ranging from economic to social. Here are some of the most common effects arising from austerity measures:
- Economic Effects - Many aggregate demand models in economics suggest a relatively simple relationship between a government's budget and economic activity. That is, austerity measures lead to depressed consumption and economic output. But some studies suggest that the relationship between austerity and economic activity is nonlinear and depend on many outside factors, which makes these effects uncertain.
- Political Effects - Aside from the fiscal effects, austerity measures can have a number of effects on a country's politics. Since most austerity measures target developmental and social spending, social unrest is one of the most common after effects of austerity implementation. For instance, Greece saw a number of violent protests to measures undertaken in 2011 and 2012.
- Social Effects - Austerity measures also have a big impact on everyday life, since governments tend to be both large employers and social nets. For instance, the Family & Parenting Institute projected that median household income in the U.K. would fall in real terms by 4.2% over the five years following the government's cutbacks in 2011.
Austerity, Spending & Taxes
Austerity measures are implemented in order to cut federal deficits that can cripple a government's ability to finance its operations. However, there are two other methods that can also be used to address federal deficits - growth and taxes.
Here are the three ways to address federal deficits:
- Spending - Countries can increase spending in hopes of spurring growth rates. The higher growth rates increase GDP and reduce debt as a percentage of GDP and make it more manageable. Of course, failure to increase growth can lead to even more debt, while government spending is rarely the most efficient type of spending.
- Austerity - Austerity measures involve cutting government spending. These cuts can produce immediate reductions in future debt, which means debt as a percentage of GDP will decline, if GDP remains stable. Of course, the problem here is that austerity usually has the opposite effect of reducing growth rates over time.
- Taxes - Raising taxes can help shore up government finances, but they put strain on taxpayers and corporations operating within the country. Conversely, lowering taxes can be a way to spur growth by encouraging private spending and investment.
The Keynes vs. Hayek Debate
John Maynard Keynes and Friedrich Hayek were two famous economists with differing opinions on how to address the boom bust cycle that leads to budget deficits. In fact, the debates between these two economists were somewhat famous for being rather boisterous and unruly.
Keynes argued that governments should intervene to help put jobless back to work by implementing economic stimulus and other programs. If these people were employed, GDP growth would accelerate and debt as a percentage of GDP would be reduced. The prospects of a long-term growth rate would also making financing current projects much easier.
Hayek insisted that these programs would simply delay a day of reckoning. Instead, the economist argued that governments should instead reduce spending and taxes in order to make room for the free markets to determine the right course of action. While this could mean a deleveraging in the short-term, it would equate to a far healthier long-term economy.