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.

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.

Related Topics

• What is Government Spending?
• Autonomous Spending
• Autonomous Consumption
• Fiscal Policy
• Expansionary Fiscal Policy
• Contractionary Fiscal Policy
• Progressive vs Regressive Tax
• Marginal Tax Rates
• Proportional Tax
• Trickle Down Theory
• Discretionary Fiscal Policy
• Automatic Stabilizers
• Effects of Discretionary Policy (Interest Rates & Lags)
• Crowding Out Effect 
• National Debt
• Government Borrowing
• Golden Rule
• Ricardian Equivalence
• Balanced Budget - Deficit and Surplus
• National Debt
• Standardized Employment Budget
• Deficit Hawk
• Austerity
• Twin Deficits
• Fiscal Policy and the Aggregate Supply and Demand Curve
• Stabilization Policy
• Robin Hood Effect
• Ricardo Barro Effect
• Automatic Stabilizers
• Standardized Employment Budget
• How Does Fiscal Policy Affect Interest Rates? 
• Crowding Out
• Types of Lag in Fiscal Policy
• Temporary and Permanent Fiscal Policy
• Limitations of Fiscal Policy?
• How Politics Affects Discretionary Fiscal Policy
• Government Borrowing
• National Savings and Investment Identity
• Debtor Nation
• Fiscal Policy Affects Trade Balances
• Twin Deficits
• Exchange Rates Affect Budget and Trade Deficits
• What are the risks of chronic large deficits in the United States?
• How Fiscal Policy Can Affect Trade Imbalances
• Government Borrowing Affect Private Savings
• Ricardian Equivalence
• Fiscal Policy Affects Investment and Economic Growth
• Crowding Out of Physical Capital Investment?
• How Does Government Borrowing Affect Interest Rates in Financial Markets?
• Government Investment in Physical Capital
• Public Investment in Human Capital
• Fiscal Policy Can Affect Technology Development

• Economic Cycle or Business Cycle
• Business Cycle Indicator
• Peak and Trough
• Recession and Depression
• Hard Landing vs Soft Landing
• Economic Bubble
• Boom and Bust Cycle
• Great Depression
• Baby Boomer Age Wave Theory

• Skyscrapper Effect (Economics)
• V-Shaped Recovery
• W-Shaped Recovery
• U-Shaped Recovery
• Kondratieff Wave Cycle
• Contagion
• Feedback Rule Policy
• American Customer Satisfaction Index
• CNN Effect
• Bureau of Economic Analysis
• Business Starts Index
• American Recover and Reinvestment Act
• Abenomics
• Emergency Economic Stabilization Act of 2008
• Commodity Credit Corporation
• Humphrey Hawkins Act

• Real Economic Growth Rate
• Fox-Trot Economy

• Stagnation
• Neoclassical Growth Theory
• Exogenous Growth Theory
• Endogenous Growth Theory
• New Growth Theory - Explained
• Classical Growth Theory - Explained
• Real Economic Growth Rate - Explained
• Plutonomy