Austerity

If it’s done correctly, austerity isn’t always bad news.

Since the financial crisis of 2008, everyone’s been talking about “austerity” – not just economists, but the general public too. But what exactly does it mean?

Simply put, austerity is a type of government policy that aims to reduce a budgetary deficit – that is, when government spending is more than the revenue it receives – so that the level of debt is stable. There are two ways governments can do this: raising taxes and cutting spending.

Although some economists and politicians view austerity as a sensible policy, it can be unpopular with the general public. And yet evidence shows that it is possible to be reelected after introducing controversial austerity measures. What’s more, austerity can even be good for the economy as a whole.

The key message here is: If it’s done correctly, austerity isn’t always bad news.

In an ideal world, there’d be no need for austerity. Governments would accumulate a surplus when the economy is booming, and run a deficit when it’s in recession – just like a seasonal worker might save heavily when money comes in and use the savings when work dries up. Overall, the surplus and the deficit would balance each other out, eliminating the need for drastic austerity measures.

But that’s not how it tends to play out. First of all, it’s common for governments to keep borrowing even during an economic boom. And secondly, an unexpected crisis – be it a pandemic or a war – often requires high levels of spending.

For countries like Italy and Greece, the Great Recession of 2008 was especially terrible because they had been building up far too much debt in the years leading up to the crisis. So, when the sudden shock of 2008 arrived, they were in two kinds of trouble at once.

In cases like that, the need for austerity is clear. And even though austerity measures can go wrong, as in the case of Greece, a correctly managed program of austerity can succeed in lowering the deficit without doing serious damage to the economy.

How is this possible? Well, through detailed analysis of a large dataset, the authors got closer to an answer. Despite the complexity of the question, they found that one point tends to hold true: spending cuts often lead to better outcomes than tax increases.