Austerity

In economics, austerity refers to a policy of deficit-cutting by lowering spending often via a reduction in the
amount of benefits andpublic 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]

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 representative example 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]

More reading on Anti-austerity_protests

http://en.wikipedia.org/wiki/Anti-austerity_protests