What is Austerity?

Published by Thomas Herold in Economics, Laws & Regulations

'Austerity' is explained in detail and with examples in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Austerity proves to be an unpopular group of government economic policies which a country engages in usually unwillingly in order to reign in public deficits and to reduce government owed debts. These drastic measures turn out to be the response from the government in question to their public debt which becomes so big that the default possibilities on debt service payments become a serious risk.

Such default risk can get out of hand rather fast. This happens when a nation, corporation, or even person falls further and further into debt, lenders retaliate by exacting a greater interest rate on subsequent loans, and force the downward vicious spiral to become all the worse as it costs more to raise capital.

Austerity became necessary after the global financial crisis and meltdown which erupted in 2007 bankrupted numerous especially western developed governments because they were gathering lower tax revenues. This exposed government spending and debt levels which were ultimately unsustainable.

There were a few European countries including Greece, Spain, and the United Kingdom that tried out austerity because they needed to reduce their budget outlays. It became practically forced on them by the economic conditions brought on by the ensuing recession throughout Europe. In this economic contraction, many eurozone members could no longer effectively service their rising debts since they had no control over the euro currency to print more of it and devalue their currency as they needed to do.

There are three principal kinds of such austerity measures. The first one focuses on creating higher tax and fee revenues. Many times this is to encourage additional government outlays and spending. The end goal of such a plan is to encourage growth by seizing the rewards of higher taxation and then spending it to lubricate the stalling economy.

A second form is often referred to as the Angela Merkel model in honor of the long time chancellor of Germany. This kind concentrates on increasing taxes at the same time as it reduces expenditures on any services deemed to be less essential than others. The final form is a reduced taxation and simultaneous reduced spending effort. This is the means that most free market enthusiasts espouse.

The majority of economists can actually agree on one thing, which is that increasing taxes will boost ultimate revenue collection. Many different struggling European nations adopted this form of austerity to solve their budgetary problems. Greece boosted its national value added tax VAT rate to 23 percent back in 2010 as well as adding another 10 percent import duties on vehicles. For those with higher income brackets, the Greek government in Athens increased their income tax rates. Besides this a few new taxes were implemented and assessed on property holdings and values.

Besides increasing taxes and boosting revenues, governments can also reduce the amount of spending which they pursue. This is often regarded as the more effective way of lessening the deficit, though it is far more painful for the lower classes of society as well as the poor which lose access to important basic government services such as high quality health care and welfare and rent subsidies as a result. Cutting spending can take a wide range of forms. There are subsidies, grants, redistribution of wealth, government services, entitlement programs, national defense, government employee benefits, and foreign aid given to poor countries. Reducing spending is true, albeit often quite painful, austerity.

There are a wide variety of historical examples of such austerity measures. The most successful one in the modern era in response to a recession happened within the U.S. in the years of 1920 and 1921. President Warren Harding drastically reduced the federal budget by nearly 50 percent. He simultaneously reduced taxes on all income brackets and cut the debt by over 30 percent. Greece is another much sadder case of this form of spending cuts and tax increases. While they have managed to cut the national deficit and debt through these programs and policies, the country has been in and out of painful and deep recessions for most of the past decade as a direct result.

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The term 'Austerity' is included in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.