austerity

In economics, austerity refers to a policy of deficit-cutting by lowering spending often via a reduction in the amount of benefits and public services provided.^[1] Austerity policies are often used by governments to try to reduce their deficit spending^[2] and are sometimes coupled with increases in taxes to demonstrate long-term fiscal solvency to creditors.^[3]

Supporters of austerity predict that under expansionary fiscal contraction (EFC), a major reduction in government spending can change future expectations about taxes and government spending, encouraging private consumption and resulting in overall economic expansion.^[4]

Critics argue that, in periods of high unemployment, austerity policies are counter-productive, because deficit cutting reduces GDP (which typically means less tax revenue to pay off the debt); and that short-term stimulus is necessary to deal with deficits in the long-term.^[5]

"Austerity" was named the word of the year by Merriam-Webster in 2010.^[6]

Reasons for undertaking 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 Fund (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'.

Typical effects

Development projects, welfare, and other social spending are common programs that are targeted for cuts: Taxes, port and airport fees, 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.^[7]

Theoretical considerations

Contemporary mainstream economists consider macroeconomic policy in a dynamic stochastic general equilibrium (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.^[8] 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 acts as a funding mechanism for the government.^[9] 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.^[9][10]

Controversy

Austerity programs can be controversial. In the Overseas Development Institute briefing paper "The IMF and the Third World" the ODI addresses five major complaints against the IMF's austerity 'conditionalities'. These complaints include these measures being "anti-developmental", "self-defeating", and "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.^[11][12][13]

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 corporations, churches, and private tax-exempt institutions such as universities, which currently pay no taxes at all.^[14]

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.^[15][16] 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. The third round austerity has been approved by the Greece parliament on February 12, 2012 and has met strong opposition especially in the cities of Athens and Thessaloniki where the police have clashed with demonstrators.

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.^[17]

The "Age 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 what he called years of excessive government spending.^{[18] [19]}

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".^[20]

Examples of austerity

This section is in a list format that may be better presented using prose. You can help by converting this section to prose, if appropriate. Editing help is available. (June 2011)

• Argentina, 1952,2012^[21]
• Cuba, 1991
• Czech Republic, 2010
• Germany, 2011^[22]
• Greece, 2010–2012^[23]
• Ireland, 2010
• Israel, 1949–1959
• Italy, 2010^[24]
• Japan, 2010^[25]
• Latvia, 2009^[26]
• Mexico, 1985^[27]
• Netherlands, 1982–1990, 2003–2006, 2011
• Canada, 1994
• Nicaragua, 1997^[28]
• Palestinian Authority, 2006^[29]
• Romania, 2010^[30]
• Portugal, 2010–2011
• Puerto Rico, 2009–2013^{[clarification needed for future year]}
• Spain, 1979,^[31] 2010
• United Kingdom, during and after the two World Wars, 2011–2014^{[clarification needed for future year][32]}
• United States, 2011-, austerity measures for approval of social security disability benefits
• Naples, Italy 2012

See also

• Functional finance
• Paradox of thrift
• Planned shrinkage

References

External links

Look up austerity in Wiktionary, the free dictionary.

• The Austerity Zone: Life in the New Europe - videos by The New York Times
• Video: Richard Koo debates Kenneth Rogoff about the need for austerity, Institute for New Economic Thinking inaugural conference, April 22, 2010
• Socialist Studies Special Edition on Austerity (2011)