Austerity

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Blog Author :

Prakhar Gajendrakar

Edited by :

Raisa Ali

Reviewed by :

Dheeraj Vaidya, CFA, FRM

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Austerity Meaning

Austerity refers to the economic policies used by the government to reduce budget deficits and solve the debt crisis. These policies are commonly directed to increase tax rates and reduce government spending. It reduces the risk of financial instability.

In simple words, it helps the government in the careful management of resources in difficult situations. However, it is not a common or necessary measure. If implemented at the wrong time, it can cause disastrous consequences. The government is generally forced to take such measures by its creditors. For example, bondholders pressure the government to confront the bond market collapse using such measures.

Table of contents
  • Austerity definition portrays it as unanticipated and unusual policies taken by a government to minimize the public sector debt and budget deficit.
  • It is done to regain the financial health of a nation. The policies bring discipline to spending and aim to attain minimalistic living.
  • Its type includes raising taxes to fund government spending, raising taxes and cutting expenditures simultaneously, and lowering taxes and cutting down government spending simultaneously.
  • It is important to restore the confidence of creditors in the nation's ability to pay off the debt.

Austerity Measures Explained

Austerity measures utilize contractionary policies that control government spending and tax policies to protect the government's financial health and credibility. The most common approach includes applying deflationary fiscal policies disclosing raising taxes and lowering expenditures.

When a country has taken debt from different countries and global organizations and expects an outbreak of debt crisis or debt spiral, it becomes crucial to implement curing and prevention strategies to restore creditors' confidence in the country. However, these measures are not healthy for a society, specifically amid a recession. It can lead to violation of human rights, increased unemployment, and loss of assets. Moreover, if such measures' implementation occurs repeatedly, it can negatively affect economic growth.

It can be good, bad, and ugly. It is viewed as good when the government sector suffers the most without passing much pressure onto the private or public sector. In contrast, the measures are categorized as bad if the private sector and the public suffer the most. Finally, it turns ugly if only the private sector suffers and adjusts due to the measures.

Types

Austerity types
  • Raising taxes to fund spending: It is the basic ideology where the government raises tax rates levied on the citizens to generate more revenue. Also, the government can reduce or stop various tax credit provisions. The increase in revenue can be used to fund government spending. It is the most common strategy adopted by nations stuck with the national debt.
  • Raising taxes and cutting spending: It is a strategy where a country raises taxes and cuts specific government spending. It helps in reducing the wide gap between government expenditure and revenue.
  • Lower taxes and lower government spending: It involves simultaneously lowering taxes and reducing government spending. It exemplifies a combination of contractionary and expansionary policy.

Example

US: Austerity measures in the US surrounded the US national debt crisis, mainly caused by a significant rise in federal spending following the Great Recession. The policies were framed to encourage reasonable cuts in government spending and an increase in tax rates. When Congress refused to pass the budget based on it in 2011, the government almost faced a shutdown due to a lack of funding. However, the situation was eased by the agreement on a moderate reduction in spending. Congress also delayed the budget sequestration and applied increased tax rates on the wealthy to combat the potential fiscal cliff scenario.

UK: In the UK, these measures were adopted to cope with the crisis followed by the Second World War and the impacts of the 2007-2008 financial crisis. To achieve a current balance and favorable national debt to GDP ratio government introduced substantial reductions in public expenditure. In addition, there was a reduction in government jobs, increased retirement age, specific budget cuts, and halted certain income tax allowances.

Greece: During the debt crisis of 2010, Greece used targeted tax reforms and other measures like job cuts, lowering public employee wages, decreasing pension benefits, and cutting subsidies to reduce expenditure and collect maximum revenue. However, the sudden reforms resulted in ruinous effects like a weak banking system, increased debt to GDP ratio, and a high unemployment rate.

Frequently Asked Questions (FAQs)

Define austerity?

It refers to the unanticipated policies implemented by the government to deal with increasing public debt and budget deficit scenarios effectively. Such procedures are not common and are introduced only during the worst phases when the government anticipates extreme difficulty settling liabilities. As a result, it helps the government regain the nation's financial health, lessen the dependence on borrowing and lower the debt to GDP ratio. However, it can increase unemployment and reduce GDP growth if not implemented appropriately.

What are common austerity program examples?

The programs are implemented to bring discipline in spending and minimalistic living to save the economy from falling into adverse economic situations. It is done by ensuring limited government spending and increased tax rates to collect more revenue. Examples include a sudden increase in tax rates aiming at wealthy people, reducing the number of government jobs, raising the retirement age, lowering the wages, removing income tax credits, cutting down pension benefits, and removing subsidies.

What is the synonym of austerity?

Some synonyms are prudence, self-discipline, simplicity, asceticism, and frugality.