Austerity – definition and meaning

Austerity is an economic policy that focuses on raising taxes and reducing the amount of government spending. These spending or budget cuts are often referred to as ‘cutbacks’.

According to ft.com/lexicon, austerity measures refer to:

“Official actions taken by the government, during a period of adverse economic conditions, to reduce its budget deficit using a combination of spending cuts or tax rises.”

Governments typically adopt austerity measures when facing difficulties in meeting debt obligations. This can happen when governments borrow in a foreign currency which they cannot issue, or if they have been forbidden from issuing their own currency (printing money).

austerity protest
One hundred thousand people in front of the Greek parliament protesting against economic austerity measures.

When this type of situation occurs, banks and investors tend to lose confidence in a governments’ ability to pay back debt – they might refuse to refinance existing debts or significantly increase interest rates.

However, the International Monetary Fund (IMF) may act as a lender of last resort as long as the government adopts an economic austerity policy (called IMF’s austerity conditionalities).

Governments have three goals in mind when adopting austerity measures:

  1. Avoid the accumulation of deficits that increase total debt.
  2. Reduce high inflation.
  3. Limit over-investment and speculative bubbles.

One of the problems with austerity policies is that they lead to increases in unemployment levels over the short-term. This increases spending on unemployment benefits and reduces tax revenues, which partially offsets the austerity measures.

Balancing stimulus and austerity

It is possible to take steps that ensure future spending will go down (e.g. raising the retirement age) while also creating short-term spending to create jobs.

In August 2011, IMF managing director Christine Lagarde wrote:

“For the advanced economies, there is an unmistakable need to restore fiscal sustainability through credible consolidation plans. At the same time we know that slamming on the brakes too quickly will hurt the recovery and worsen job prospects.”

“So fiscal adjustment must resolve the conundrum of being neither too fast nor too slow. Shaping a Goldilocks fiscal consolidation is all about timing.”

She added:

“What is needed is a dual focus on medium-term consolidation and short-term support for growth. That may sound contradictory, but the two are mutually reinforcing. Decisions on future consolidation, tackling the issues that will bring sustained fiscal improvement, create space in the near term for policies that support growth.”

Controversy

Austerity measures are controversial. The Overseas Development Institute (ODI) briefing paper, “The IMF and the Third World”, points out several problems with the IMF’s austerity conditionalities.

The paper concludes that these measures are:

  • Anti-developmental.
  • Self-defeating.
  • Have an adverse impact on the poorest segments of the population.

The Keynesian school of thought

At the end of the 1930s, after almost ten successive years of austerity measures in response to the Great Depression, a growing number of economists argued against austerity. John Maynard Keynes (1983-1946), a British economist, became well-known for his anti-austerity views.

Keynes argued that “The boom, not the slump, is the right time for austerity at the Treasury.”

Keynesian economists argue that government should be in deficit when the economy is in recession, so that unemployment falls and GDP can grow.

On 2 June, 2014, Jonathan Ostry, deputy director of the IMF research department, wrote in the blog IMFDirect that governments which face lower risks of a sovereign debt crisis could be unnecessarily damaging their economies by imposing harsh austerity programs purely to pay back creditors more rapidly.

Video – Mark Blyth on Austerity
Mark Blyth is political economist, author of several books and a Professor of Political Science and International and Public Affairs. In the video below Mark Blyth explains global trend toward Austerity budgets.