Over the past several years there has been a lot of financial talk on the news that have been strong enough to move the markets. One such item that has been repeated a lot is talk about “austerity measures.” This is especially common when talking about Spain and Greece and a few other European countries. While it is clear from the context that it has something to do with government spending, and the economic situation of that particular country, what exactly are austerity measures?
When a country starts to get into economic trouble, the government generally will step in to help get things back on track. While most of the time, the remedy is fairly simple, there are times when more drastic measures need to be taken. For example, here in the US we have seen several heavy doses of stimulus money poured into the economy. While the effectiveness of these quantitative easing can be argued, the fact is, government spending usually jumpstarts the economy when people and businesses are unable to do so themselves. This is great when the government has the means to do so, but what if they are already strapped for cash?
Selling treasury bonds is a way the government raises money. But a bond is only as good as the company (or in this case government) backing it. If there are questions about the government’s ability to make good on their debt, or their solvency, there is a possibility of the bonds being downgraded. This will both cause fewer people to want to invest in that government, and it will cause the interest rates to rise (higher risk means they need to entice investors with a higher reward). In the end, it ends up costing the government even more money.
Instead of risking a downgrade, governments will take measures to cut spending and raise taxes. These austerity (from the root “austere” meaning severe or strict) measures are usually drastic attempts to prove to the ratings agencies that the government is willing to do what is necessary to keep themselves in business. Unfortunately what is good for the government is often not very good for the people. Less government spending and higher taxes can lead to higher unemployment and fewer services to provide for the residents of the country.
The biggest debate about austerity measures is: do they work? Many critics think more government spending is the answer, not less. We have seen the debate here in the US with the fiscal cliff, where the government is facing forced austerity measures. While nobody likes paying more and getting less, the common welfare of a country should be the main focus. Sometimes it is necessary for everyone to tighten their belts today in order to have the services tomorrow. Austerity measures, at their most basic definition, are the opposite of a stimulus package.
First off, awesome article. You don’t see these types of articles on most personal finance blogs. The mention of “austerity” usually causes people to “change the channel.”
I want to add that although austerity is usually coupled with raising taxes, the term itself refers to the reduction in spending. For instance, I think reduced spending is good – but raising taxes is bad. So defining both with the word austerity could lead to confusion.
As I was studying Economics in college, we were only taught Keynesian economics: meaning the government steps in, as you said. But, I’m afraid the Keynesians are to blame for the constant boom & bust cycles we face. If the government continues to artificially prop up the markets, we’ll continue to encounter crisis after crisis. We need to return to the fundamentals of saving, using the savings to invest, and using the investments to produce. Instead, we’re focused on consuming, consuming, consuming.
Thank you. I felt that this is such a big topic in the news that it needed to be addressed. I completely agree that we need to return to basic fundamentals.