Austerity - Explained
What are Austerity Measures?
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Table of ContentsWhat is Austerity?How do Austerity Measures Work?Taxes and AusterityGovernment Spending and AusterityHistorical Examples of Austerity MeasuresHistorical Examples of Austerity Measures
What is Austerity?
Austerity is an economic policy that the government uses to reduce or control public sector debt. When used as a tool by the government, austerity is an extreme economy that is enforced by the government when the amount owed as public debt is huge. If public debt is huge and there is a possibility of default, the government activates austerity measures that minimize public debt and expenditure. Austerity measures can take the form of spending cuts or tax increases in a country or can be both. During austerity periods, there is little money in circulation and the money available is spent on important things and not immaterial things.
Back to: ECONOMIC ANALYSIS & MONETARY POLICY
How do Austerity Measures Work?
Governments, organizations or individuals who find it difficult to pay their debts use austerity measures, especially when there is an outrageous difference between government income (receipts) and expenditure. For government, a rise in public debt comes with default risk and when the government defaults, more debts are accrued which is why the government uses austerity measures. Basically, austerity is used in an economy to cut down public debt and stimulate growth. The major austerity measures used by the government are;
- Revenue generation through taxation, this measure favors government spending.
- Increasing taxes and reducing unimportant spending.
- Lower government spending and lower taxes.
Taxes and Austerity
More clearly, governments of many nations have begun to use austerity as a tool to reduce budget concerns and this has raised some concerns, especially by tax experts and economists. On the issue of taxes, economists are pitched in different tents, with the likes of Arthur Laffer arguing that when taxes are reduced, there will be more economic activities in a country and this will boost the revenue that the country generates. Despite the position economists highlighted above, some economists maintain that increased taxes lead to increased revenues. Several European countries however supported and utilized raising taxes to increase revenue.
Government Spending and Austerity
Austerity measures help in reducing public sector debt and also control government budget deficits. When austerity is used by a government, it can be through spending cuts or increasing taxes. A reduction in government spending is a form of austerity measure as this helps to minimize deficit. There are numerous austerity measures that the government can use, the major ones;
- Spending cuts, that is, reducing government spending or expenses, including the elimination of proposed programs or projects.
- An increase in taxes to generate more revenue.
- Cutting unnecessary government functions such as reducing government services.
- Cessation of government recruitment or retrenchment of some government workers.
- Lowering of taxes and lowering of government spending.
Historical Examples of Austerity Measures
Recession and economic breakdown are conditions that often warrant the implementation of austerity by the government. In the United States, austerity was in 1920 as a remedy for recession. The austerity measures used during this period of recession was cutting down government budget and expenses, the reduction amounted to almost 50% as directed by Warren G. Harding, the then President of the U.S.
Historical Examples of Austerity Measures