Austerity
Encyclopedia
In economics
, austerity is a policy
of deficit-cutting, lower spending
, and a reduction in the amount of benefits
and public services
provided. Austerity policies are often used by governments to reduce their deficit spending
while sometimes coupled with increases in tax
es to pay back creditor
s to reduce debt. "Austerity" was named the word of the year by Merriam-Webster
in 2010.
(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
'.
projects, welfare, and other social spending are common programs that are targeted 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 protest movements claiming significant decline in standard of living. A case in point 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
.
(DSGE) framework, where fiscal policy is discussed within an optimal taxation framework that assumes a representative agent is optimizing over a long-term horizon. The reasoning 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, from a modern mainstream macroeconomist's point of view, reducing government deficit allows the private sector to consume more and support the economy. This viewpoint stems from their belief in the existence of a general economic equilibrium, which predicts that economic fluctuations revert back toward a "normal" state of affairs automatically. For this reason econometric models that are used in economic forecasting are calibrated to show convergence to full resource utilization and employment despite government's fiscal tightening.
Old-Keynesians
, such as Alvin Hansen
, had a totally opposite view: they 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 act 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 they do borrowing in foreign currencies or they are part of a larger currency area like the eurozone where they do not have the right to issue money.
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 corporation
s, 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 June 29, 2011.
Opponents argue that austerity measures tend to depress economic growth, which ultimately causes governments to lose more money in tax revenues. In countries with already anemic economic growth, austerity can engender deflation which inflates existing debt. This 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.
” was popularized by British Conservative leader David Cameron
in his keynote speech to the Conservative party forum in Cheltenham on April 26, 2009, when he committed to put an end to years of excessive government spending.
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...
, austerity is a policy
Economic policy
Economic policy refers to the actions that governments take in the economic field. It covers the systems for setting interest rates and government budget as well as the labor market, national ownership, and many other areas of government interventions into the economy.Such policies are often...
of deficit-cutting, lower spending
Government spending
Government spending includes all government consumption, investment but excludes transfer payments made by a state. Government acquisition of goods and services for current use to directly satisfy individual or collective needs of the members of the community is classed as government final...
, and a reduction in the amount of benefits
Welfare
Welfare refers to a broad discourse which may hold certain implications regarding the provision of a minimal level of wellbeing and social support for all citizens without the stigma of charity. This is termed "social solidarity"...
and public services
Public services
Public services is a term usually used to mean services provided by government to its citizens, either directly or by financing private provision of services. The term is associated with a social consensus that certain services should be available to all, regardless of income...
provided. Austerity policies are often used by governments to reduce their deficit spending
Deficit spending
Deficit spending is the amount by which a government, private company, or individual's spending exceeds income over a particular period of time, also called simply "deficit," or "budget deficit," the opposite of budget surplus....
while sometimes coupled with increases in tax
Tax
To tax is to impose a financial charge or other levy upon a taxpayer by a state or the functional equivalent of a state such that failure to pay is punishable by law. Taxes are also imposed by many subnational entities...
es to pay back creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
s to reduce debt. "Austerity" was named the word of the year by Merriam-Webster
Merriam-Webster
Merriam–Webster, which was originally the G. & C. Merriam Company of Springfield, Massachusetts, is an American company that publishes reference books, especially dictionaries that are descendants of Noah Webster’s An American Dictionary of the English Language .Merriam-Webster Inc. has been a...
in 2010.
Reasons for taking austerity measures
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 they have been legally forbidden from issuing their own currency. In such a situation, banks 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 FundInternational Monetary Fund
The International Monetary Fund is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world...
(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
Conditionality
Conditionality is a concept in international development, political economy and international relations and describes the use of conditions attached to a loan, debt relief, bilateral aid or membership of international organizations, typically by the international financial institutions, regional...
'.
Typical effects
DevelopmentEconomic development
Economic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area...
projects, welfare, and other social spending are common programs that are targeted 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 protest movements claiming significant decline in standard of living. A case in point 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
United Nations
The United Nations is an international organization whose stated aims are facilitating cooperation in international law, international security, economic development, social progress, human rights, and achievement of world peace...
official warned that the second package of austerity measures in Greece could pose a violation of human rights
Human rights
Human rights are "commonly understood as inalienable fundamental rights to which a person is inherently entitled simply because she or he is a human being." Human rights are thus conceived as universal and egalitarian . These rights may exist as natural rights or as legal rights, in both national...
.
Theoretical considerations
Contemporary mainstream economists consider macroeconomic policy in a dynamic stochastic general equilibriumDynamic stochastic general equilibrium
Dynamic stochastic general equilibrium modeling is a branch of applied general equilibrium theory that is influential in contemporary macroeconomics...
(DSGE) framework, where fiscal policy is discussed within an optimal taxation framework that assumes a representative agent is optimizing over a long-term horizon. The reasoning 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, from a modern mainstream macroeconomist's point of view, reducing government deficit allows the private sector to consume more and support the economy. This viewpoint stems from their belief in the existence of a general economic equilibrium, which predicts that economic fluctuations revert back toward a "normal" state of affairs automatically. For this reason econometric models that are used in economic forecasting are calibrated to show convergence to full resource utilization and employment despite government's fiscal tightening.
Old-Keynesians
Neo-Keynesian Economics
Neo-Keynesian economics is a school of macroeconomic thought that was developed in the post-war period from the writings of John Maynard Keynes. A group of economists , attempted to interpret and formalize Keynes' writings, and to synthesize it with the neo-classical models of economics...
, such as Alvin Hansen
Alvin Hansen
Alvin Harvey Hansen , often referred to as "the American Keynes," was a professor of economics at Harvard, a widely read author on current economic issues, and an influential advisor to the government who helped create the Council of Economic Advisors and the Social security system...
, had a totally opposite view: they 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
Wealth effect
The wealth effect is an economic term, referring to an increase in spending that accompanies an increase in perceived wealth.-Effect on individuals:...
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
Chartalism
Chartalism is a descriptive economic theory that details the procedures and consequences of using government-issued tokens as the unit of money. The name derives from the Latin charta, in the sense of a token or ticket...
austerity measures by a national government are usually counterproductive because neither taxation nor bond issuance act 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
Fixed exchange rate
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.A fixed exchange rate is usually used to...
to either foreign currency or gold, or they do borrowing in foreign currencies or they are part of a larger currency area like the eurozone where they do not have the right to issue money.
Controversy
Austerity programs can be controversial, as 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
Richard D. Wolff
Richard D. Wolff is an American economist, well-known for his work on Marxian economics, economic methodology, and class analysis.- Early and personal life :...
has stated that instead of cutting government programs and raising taxes, austerity should be attained by collecting (taxes) from non-profit
Non-profit organization
Nonprofit organization is neither a legal nor technical definition but generally refers to an organization that uses surplus revenues to achieve its goals, rather than distributing them as profit or dividends...
multinational corporation
Multinational corporation
A multi national corporation or enterprise , is a corporation or an enterprise that manages production or delivers services in more than one country. It can also be referred to as an international corporation...
s, 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
Government
Government refers to the legislators, administrators, and arbitrators in the administrative bureaucracy who control a state at a given time, and to the system of government by which they are organized...
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 June 29, 2011.
Opponents argue that austerity measures tend to depress economic growth, which ultimately causes governments to lose more money in tax revenues. In countries with already anemic economic growth, austerity can engender deflation which inflates existing debt. This can also cause the country to fall into a liquidity trap
Liquidity trap
A liquidity trap is a situation described in Keynesian economics in which injections of cash into an economy by a central bank fail to lower interest rates and hence to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as...
, 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.
The "Age of Austerity"
The term “Age of austerityAge 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 April 26, 2009, when he committed to put an end to years of excessive government spending....
” was popularized by British Conservative leader David Cameron
David Cameron
David William Donald Cameron is the current Prime Minister of the United Kingdom, First Lord of the Treasury, Minister for the Civil Service and Leader of the Conservative Party. Cameron represents Witney as its Member of Parliament ....
in his keynote speech to the Conservative party forum in Cheltenham on April 26, 2009, when he committed to put an end to 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
- SpartaSpartaSparta or Lacedaemon, was a prominent city-state in ancient Greece, situated on the banks of the River Eurotas in Laconia, in south-eastern Peloponnese. It emerged as a political entity around the 10th century BC, when the invading Dorians subjugated the local, non-Dorian population. From c...
, 10th century BC - Argentina, 1952
- Cuba, 1991Special PeriodThe Special Period in Time of Peace in Cuba was an extended period of economic crisis that began in 1991 after the dissolution of the Soviet Union and, by extension, the Comecon. The economic depression of the Special Period was at its most severe in the early-to-mid 1990s before slightly declining...
- Czech Republic, 2010
- Germany, 2011
- Greece, 2010–2011
- Ireland, 2010
- IsraelAusterity in IsraelFrom 1949 to 1959, the state of Israel was, to a varying extent, under a regime of austerity , during which rationing and similar measures were enforced.-Rationale:...
, 1949–1959 - Italy, 2010
- Japan, 2010
- Latvia, 2009
- Mexico, 1985
- Netherlands, 1982–1990, 2003–2006, 2011
- Canada, 1994
- Nicaragua, 1997
- Palestinian Authority, 2006
- Romania, 2010
- Portugal, 2010–2011
- Puerto Rico, 2009–2013
- Spain, 1979, 2010
- United Kingdom, during and after the two World Wars, 2011–2014
External links
- The Austerity Zone: Life in the New Europe - videos by The New York TimesThe New York TimesThe New York Times is an American daily newspaper founded and continuously published in New York City since 1851. The New York Times has won 106 Pulitzer Prizes, the most of any news organization...
- Video: Richard Koo debates Kenneth Rogoff about the need for austerity, Institute for New Economic ThinkingInstitute for New Economic ThinkingThe Institute for New Economic Thinking is a New York City-based nonprofit think tank founded in October 2009 with a $50 million pledge by George Soros as a result of the Financial crisis of 2007-2010.It has nobel laureates George Akerlof, Sir James Mirrlees, A...
inaugural conference, April 22, 2010