Austerity

For other uses, see Austerity (disambiguation).

For the current opposition to present-day austerity measures, see Anti-austerity movement.

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In economics, austerity is a set of policies with the aim of reducing government budget deficits. Austerity policies may include spending cuts, tax increases, or a mixture of both. Austerity may be undertaken to demonstrate the government's fiscal discipline to their creditors and credit rating agencies by bringing revenues closer to expenditures. In most macroeconomic models, austerity policies generally increase unemployment in the short run, as government spending falls reducing jobs in the public and private sector or both, while tax increases reduce household disposable income and thus consumption. The U.S. Congressional Budget Office illustrated this when comparing unemployment under alternative fiscal scenarios.

Unemployment increases safety net spending and further reduces tax revenues, partially offsetting the austerity measures. Government spending contributes to gross domestic product (GDP), so reducing spending may result in a higher debt-to-GDP ratio, a key measure of the debt burden carried by a country and its citizens. Higher short-term deficit spending (stimulus) contributes to GDP growth particularly when consumers and businesses are unwilling or unable to spend. This is because crowding out (i.e., rising interest rates as government bids against business for a finite amount of savings, slowing the economy) is less of a factor in a downturn, as there may be a surplus of savings.

In the aftermath of the Great Recession, austerity results in Europe have been as predicted by macroeconomics, with unemployment rising to record levels and debt-to-GDP ratios rising, despite reductions in budget deficits relative to GDP. Eurostat reported that unemployment in the 17 Euro area countries (EA17) reached record levels in March 2013, at 12.1%, up from 11.0% in March 2012 and 10.3% in March 2011; and that the overall debt-to-GDP ratio for the EA17 was 70.1% in 2008, 80.0% in 2009, 85.4% in 2010, 87.3% in 2011, and 90.6% in 2012. Further, real GDP in the EA17 declined for six straight quarters from Q4 2011 to Q1 2013. The U.S. Congressional Budget Office estimated in August 2012 that if the U.S. implemented moderate austerity measures, the unemployment rate would rise by over 1% and economic growth would be significantly reduced in 2013. The U.S. partially avoided the "fiscal cliff" through the American Taxpayer Relief Act of 2012. U.S. unemployment has fallen steadily from a peak of 10% in early 2010 to 5.3% by July 2015.

Justifications

Austerity measures are typically pursued 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 it has no right to issue or if it has been legally forbidden from issuing its own currency. In such a situation, banks and investors 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. International financial institutions such as the International Monetary Fund (IMF) may require austerity measures as part of Structural Adjustment Programmes when acting as lender of last resort. Austerity policies may also appeal to the wealthier class of creditors, who prefer low inflation and the higher probability of payback on their government securities by less profligate governments. More recently austerity has been pursued after governments became highly indebted by assuming private debts following banking crises. For example, this occurred after Ireland assumed the debts of its private banking sector during the European debt crisis. This rescue of the private sector resulted in calls to cut back the profligacy of the public sector.

According to Mark Blyth, the concept of austerity emerged in the 20th Century, when large states acquired sizable budgets. However, Blyth argues that the theories and sensibilities about the role of the state and capitalist markets which underline austerity emerged from the 17th Century onwards. Austerity is grounded in liberal economics' view of the state and sovereign debt as deeply problematic. Blyth traces the discourse of austerity back to John Locke's theory of private property and derivative theory of the state, David Hume's ideas about money and the virtue of merchants, and Adam Smith's theories on economic growth and taxes. On the basis of classic liberal ideas austerity emerged as a doctrine of neoliberalism in the 20th Century. Economist David M Kotz suggests that the implementation of austerity measures following the financial crisis of 2007–08 was an attempt to preserve the neoliberal capitalist model.

Following the Great Depression US economists regard economic downturns as accidents, instead they were regarded as part of capitalism's cyclical boom and bust nature. This view was reflected in liquidationism, a theory developed by economists in the Austrian School whereby capitalism needs slumps to produce the next round of investment and innovation. According to Joseph Schumpeter the state should not intervene and austerity is essential to economic recovery because it purges the system and allows markets to adjust. While austerity was a reoccurring theme in the Austrian school of economic theory and in German ordoliberalism it was only in the 1980s and 1990s that economists in US and Italian universities developed a serious theoretical underpinning in the expanded austerity theory. Following a neoliberal shift in the 1980s austerity became a cornerstone of prevailing development policy and the Washington Consensus.

Typical effects

Development projects, welfare, and other social spending are common programs that are targeted for cuts: taxes, port and airport fees, and train and bus fares are common sources of increased user fees. Retirement ages may be raised and government pensions reduced.

In many cases, austerity measures have been associated by critics with a decline in living standards and have led to popular protest. 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 began a 48-hour labour 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 members of parliament 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.

Around 2011, the IMF started issuing guidance suggesting that austerity could be harmful when applied without regard to an economy's underlying fundamentals. In 2013 it published a detailed analysis concluding that "if financial markets focus on the short-term behavior of the debt ratio, or if country authorities engage in repeated rounds of tightening in an effort to get the debt ratio to converge to the official target," austerity policies could slow or reverse economic growth and inhibit full employment. Keynesian economists and commentators such as Paul Krugman have suggested that this has in fact been occurring, with austerity yielding worse results in proportion to the extent to which it has been imposed.

Theoretical considerations

Main article: Keynesian economics

Red: corporate profits after tax and inventory valuation adjustment. Blue: nonresidential fixed investment, both as fractions of U.S. GDP, 1989–2012.

In the 1940s, following nearly a decade of austerity measures in response to the Great Depression, anti-austerity arguments gained more prominence. John Maynard Keynes became a well known anti-austerity economist, arguing that "The boom, not the slump, is the right time for austerity at the Treasury." Contemporary Keynesian economists argue that budget deficits are appropriate when an economy is in recession, to reduce unemployment and help spur GDP growth. Economist Paul Krugman has explained that since a government is not like a household, reductions in government spending during economic downturns will worsen crises. Across an economy, one person's spending is another person's income. If everyone is trying to reduce their spending, the economy can be trapped in what economists call the paradox of thrift, worsening the recession as GDP falls. If the private sector is unable or unwilling to consume at a level that increases GDP and employment sufficiently, Krugman argues, the government should be spending more in order to offset the decline in private spending.

An important component of economic output is business investment, but there is no reason to expect it to stabilize at full utilization of the economy's resources. High business profits do not necessarily lead to increased economic growth. When businesses and banks have a disincentive to spend accumulated capital, such as cash repatriation taxes from profits in overseas tax havens and interest on excess reserves paid to banks, increased profits can lead to decreasing growth.

Economists Kenneth S. Rogoff and Carmen M. Reinhart wrote in April 2013, "Austerity seldom works without structural reforms – for example, changes in taxes, regulations and labor market policies – and if poorly designed, can disproportionately hit the poor and middle class. Our consistent advice has been to avoid withdrawing fiscal stimulus too quickly, a position identical to that of most mainstream economists." To help improve the U.S. economy, they advocated reductions in mortgage principal for underwater homes (i.e., situations where the value of the home is less than the mortgage principal) to help reduce private debts.

Multiplier effects

In October 2012, the IMF announced that its forecasts for countries that implemented austerity programs have been consistently overoptimistic, suggesting that tax hikes and spending cuts have been doing more damage than expected and that countries that implemented fiscal stimulus, such as Germany and Austria, did better than expected. The IMF reported that this was due to fiscal multipliers that were considerably larger than expected. For example, the IMF estimated that fiscal multipliers based on data from 28 countries ranged between 0.9 and 1.7. In other words, a 1% GDP fiscal consolidation (i.e., austerity) would reduce GDP between 0.9% and 1.7%, doing much more economic damage than the 0.5 previously estimated in IMF forecasts.

In many countries, little is known about the size of multipliers, as data availability limits the scope for empirical research. For these countries, Nicoletta Batini, Luc Eyraud and Anke Weber propose a simple method — dubbed the "bucket approach" — to come up with reasonable multiplier estimates. The approach bunches countries into groups (or "buckets") with similar multiplier values, based on their characteristics. It also takes into account the effect of some temporary factors, such as the state of the business cycle.

Different tax and spending choices of equal magnitude have different economic effects. For example, the U.S. Congressional Budget Office estimated that the payroll tax (levied on all wage earners) has a higher multiplier (impact on GDP) than does the income tax (which is levied primarily on wealthier workers). In other words, raising the payroll tax by $1 as part of an austerity strategy would slow the economy more than would raising the income tax by $1, resulting in less net deficit reduction. In theory, it would stimulate the economy and reduce the deficit if the payroll tax were lowered and the income tax raised in equal amounts.

Crowding in or out

Further information: Crowding out (economics)

The term "crowding out" refers to the extent to which an increase in the budget deficit offsets spending in the private sector. Economist Laura D'Andrea Tyson wrote in June 2012, "By itself an increase in the deficit, either in the form of an increase in government spending or a reduction in taxes, causes an increase in demand. But how this affects output, employment and growth depends on what happens to interest rates. When the economy is operating near capacity, government borrowing to finance an increase in the deficit causes interest rates to rise. Higher interest rates reduce or 'crowd out' private investment, and this reduces growth. The 'crowding out' argument explains why large and sustained government deficits take a toll on growth; they reduce capital formation. But this argument rests on how government deficits affect interest rates, and the relationship between government deficits and interest rates varies. When there is considerable excess capacity, an increase in government borrowing to finance an increase in the deficit does not lead to higher interest rates and does not crowd out private investment. Instead, the higher demand resulting from the increase in the deficit bolsters employment and output directly, and the resulting increase in income and economic activity in turn encourages or 'crowds in' additional private spending. The crowding-in argument is the right one for current economic conditions."

Government budget balance as a sectoral component

Main article: Sectoral financial balances

Sectoral financial balances in U.S. economy 1990–2012. By definition, the three balances must net to zero. Since 2009, the U.S. capital surplus and private-sector surplus have driven a government budget deficit.

U.S. savings and investment; savings less investment is the private sector financial surplus

According to economist Martin Wolf, the U.S. and many Eurozone countries experienced rapid increases in their budget deficits in the wake of the 2008 crisis as a result of significant private-sector retrenchment and ongoing capital account surpluses. Policy choices had little to do with these deficit increases. This makes austerity measures counterproductive. Wolf explained that government fiscal balance is one of three major financial sectoral balances in a country's economy, along with the foreign financial sector (capital account) and the private financial sector. By definition, the sum of the surpluses or deficits across these three sectors must be zero. In the U.S. and many Eurozone countries other than Germany, a foreign financial surplus exists because capital is imported (net) to fund the trade deficit. Further, there is a private-sector financial surplus because household savings exceed business investment. By definition, a government budget deficit must exist so all three net to zero. For example, the U.S. government budget deficit in 2011 was approximately 10% of GDP (8.6% of GDP of which was federal), offsetting a foreign financial surplus of 4% of GDP and a private-sector surplus of 6% of GDP.

Wolf explained in July 2012 that the sudden shift in the private sector from deficit to surplus forced the U.S. government balance into deficit, writing, "The financial balance of the private sector shifted towards surplus by the almost unbelievable cumulative total of 11.2 per cent of gross domestic product between the third quarter of 2007 and the second quarter of 2009, which was when the financial deficit of US government (federal and state) reached its peak.... No fiscal policy changes explain the collapse into massive fiscal deficit between 2007 and 2009, because there was none of any importance. The collapse is explained by the massive shift of the private sector from financial deficit into surplus or, in other words, from boom to bust." Wolf also wrote that several European economies face the same scenario and that a lack of deficit spending would likely have resulted in a depression. He argued that a private-sector depression (represented by the private- and foreign-sector surpluses) was being "contained" by government deficit spending.

Economist Paul Krugman also explained in December 2011 the causes of the sizable shift from private-sector deficit to surplus in the U.S.: "This huge move into surplus reflects the end of the housing bubble, a sharp rise in household saving, and a slump in business investment due to lack of customers."

One reason why austerity can be counterproductive in a downturn is due to a significant private-sector financial surplus, in which consumer savings is not fully invested by businesses. In a healthy economy, private-sector savings placed into the banking system by consumers are borrowed and invested by companies. However, if consumers have increased their savings but companies are not investing the money, a surplus develops. Business investment is one of the major components of GDP.

For example, a U.S. private-sector financial deficit from 2004 to 2008 transitioned to a large surplus of savings over investment that exceeded $1 trillion by early 2009 and remained above $800 billion as of September 2012. Part of this investment reduction was related to the housing market, a major component of investment. This surplus explains how even significant government deficit spending would not increase interest rates (because businesses still have access to ample savings if they choose to borrow and invest it, so interest rates are not bid upward) and how Federal Reserve action to increase the money supply does not result in inflation (because the economy is awash with savings with no place to go).

Economist Richard Koo described similar effects for several of the developed world economies in December 2011: "Today private sectors in the U.S., the U.K., Spain, and Ireland (but not Greece) are undergoing massive deleveraging [paying down debt rather than spending] in spite of record low interest rates. This means these countries are all in serious balance sheet recessions. The private sectors in Japan and Germany are not borrowing, either. With borrowers disappearing and banks reluctant to lend, it is no wonder that, after nearly three years of record low interest rates and massive liquidity injections, industrial economies are still doing so poorly. Flow of funds data for the U.S. show a massive shift away from borrowing to savings by the private sector since the housing bubble burst in 2007. The shift for the private sector as a whole represents over 9 percent of U.S. GDP at a time of zero interest rates. Moreover, this increase in private sector savings exceeds the increase in government borrowings (5.8 percent of GDP), which suggests that the government is not doing enough to offset private sector deleveraging."

Other views

Old-Keynesians such as Alvin Hansen argue that government deficits provide the private sector with both new money for saving (the deficit) and a means to save (government interest-bearing bonds), increasing private-sector wealth, and that this wealth effect would reduce the need to save from current income. In his view, government debt enabled the private sector to continue consuming. It was therefore not a burden, at least when held domestically, but a necessity. 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. Instead all spending is done by crediting bank accounts, so national governments cannot run out of money unless they have a fixed exchange rate to either foreign currency or gold or are part of a larger currency area like the eurozone where they do not have the right to issue money.

Austrian School economists argue that austerity measures do not necessarily increase or decrease economic growth. Rather, they argue that all attempts by central governments to prop up asset prices, bail out insolvent banks, or "stimulate" the economy with deficit spending make stable growth less likely.

Empirical considerations

Public Debt to GDP Ratio for Selected European Countries – 2008 to 2012. Source Data: Eurostat

A typical goal of austerity is to reduce the annual budget deficit without sacrificing growth. Over time, this may reduce the overall debt burden, often measured as the ratio of public debt to GDP.

Relationship between fiscal tightening (austerity) in Eurozone countries with their GDP growth rate, 2008–12

Eurozone

During the European debt crisis, many countries embarked on austerity programs, reducing their budget deficits relative to GDP from 2010 to 2011. For example, according to the CIA World Factbook, Greece decreased its budget deficit from 10.4% of GDP in 2010 to 9.6% in 2011. Iceland, Italy, Ireland, Portugal, France, and Spain also decreased their budget deficits from 2010 to 2011 relative to GDP. But the austerity policy of the Eurozone achieves not only the reduction of budget deficits. The goal of economic consolidation influences, for example, the future development of the European Social Model which unfolds already liberalisation tendencies in the Eurozone as a whole.

However, with the exception of Germany, each of these countries had public-debt-to-GDP ratios that increased from 2010 to 2011, as indicated in the chart at right. Greece's public-debt-to-GDP ratio increased from 143% in 2010 to 165% in 2011. This indicates that despite declining budget deficits, GDP growth was not sufficient to support a decline in the debt-to-GDP ratio for these countries during this period. Eurostat reported that the overall debt-to-GDP ratio for the EA17 was 70.1% in 2008, 80.0% in 2009, 85.4% in 2010, 87.3% in 2011, and 90.6% in 2012. Further, real GDP in the EA17 declined for six straight quarters from Q4 2011 to Q1 2013.

Unemployment is another variable considered in evaluating austerity measures. According to the CIA World Factbook, from 2010 to 2011, the unemployment rates in Spain, Greece, Ireland, Portugal, and the UK increased. France and Italy had no significant changes, while in Germany and Iceland the unemployment rate declined. Eurostat reported that Eurozone unemployment reached record levels in March 2013 at 12.1%, up from 11.6% in September 2012 and 10.3% in 2011. Unemployment varied significantly by country.

Economist Martin Wolf analyzed the relationship between cumulative GDP growth in 2008–2012 and total reduction in budget deficits due to austerity policies (see chart at right) in several European countries during April 2012. He concluded, "In all, there is no evidence here that large fiscal contractions [budget deficit reductions] bring benefits to confidence and growth that offset the direct effects of the contractions. They bring exactly what one would expect: small contractions bring recessions and big contractions bring depressions." Changes in budget balances (deficits or surpluses) explained approximately 53% of the change in GDP, according to the equation derived from the IMF data used in his analysis.

Similarly, economist Paul Krugman analyzed the relationship between GDP and reduction in budget deficits for several European countries in April 2012 and concluded that austerity was slowing growth. He wrote: "this also implies that 1 euro of austerity yields only about 0.4 euros of reduced deficit, even in the short run. No wonder, then, that the whole austerity enterprise is spiraling into disaster."

United States

U.S. discretionary spending, mandatory spending, and revenue increases over nine-year intervals

Another historical example of austerity was in the United States, which nearly balanced its budget from 1998 to 2001 during an economic boom (as Keynes advocated, rather than during a bust). The basic strategy was to limit the rate of growth in defense and non-defense discretionary spending (which funds the major cabinet departments and agencies) during most of the 1990s, while increasing revenues along with the economy. Comparing 1990 with 1999, defense and non-defense discretionary spending grew by a total of 14%, while revenues grew by 77%. The public-debt-to-GDP ratio declined from 42.1% in 1990 to 39.4% by 1999, although it rose slightly during the interim. In contrast, from 2000 to 2009, discretionary spending grew by a total of 101%, while revenues grew by only 4%. The public-debt-to-GDP ratio increased from 34.7% in 2000 to 53.5% in 2009. Revenue grew by nearly 25% when comparing 2000 to the pre-crisis peak in 2007, still considerably less than the prior decade.

France

In April and May 2012, France held a presidential election in which the winner, François Hollande, had opposed austerity measures, promising to eliminate France's budget deficit by 2017 by canceling recently enacted tax cuts and exemptions for the wealthy, raising the top tax bracket rate to 75% on incomes over one million euros, restoring the retirement age to 60 with a full pension for those who have worked 42 years, restoring 60,000 jobs recently cut from public education, regulating rent increases, and building additional public housing for the poor. In the legislative elections in June, Hollande's Socialist Party won a supermajority capable of amending the French Constitution and enabling the immediate enactment of the promised reforms. Interest rates on French government bonds fell by 30% to record lows, fewer than 50 basis points above German government bond rates.

Latvia

Latvia's economy returned to growth in 2011 and 2012, outpacing the 27 nations in the EU, while implementing significant austerity measures. Advocates of austerity argue that Latvia represents an empirical example of the benefits of austerity, while critics argue that austerity created unnecessary hardship with the output in 2013 still below the pre-crisis level.

According to the CIA World Fact Book, "Latvia's economy experienced GDP growth of more than 10% per year during 2006–07, but entered a severe recession in 2008 as a result of an unsustainable current account deficit and large debt exposure amid the softening world economy. Triggered by the collapse of the second largest bank, GDP plunged 18% in 2009. The economy has not returned to pre-crisis levels despite strong growth, especially in the export sector in 2011–12. The IMF, EU, and other international donors provided substantial financial assistance to Latvia as part of an agreement to defend the currency's peg to the euro in exchange for the government's commitment to stringent austerity measures. The IMF/EU program successfully concluded in December 2011. The government of Prime Minister Valdis Dombrovskis remained committed to fiscal prudence and reducing the fiscal deficit from 7.7% of GDP in 2010, to 2.7% of GDP in 2012." The CIA estimated that Latvia's GDP declined by 0.3% in 2010, then grew by 5.5% in 2011 and 4.5% in 2012. Unemployment was 12.8% in 2011 and rose to 14.3% in 2012. Latvia's currency, the Lati, fell from $0.47 per U.S. dollar in 2008 to $0.55 in 2012, a decline of 17%. Latvia plans to enter the euro zone in 2014. Latvia's trade deficit improved from over 20% of GDP in 2006 to 2007 to under 2% GDP by 2012.

Eighteen months after harsh austerity measures were enacted (including both spending cuts and tax increases), economic growth began to return, although unemployment remained above pre-crisis levels. Latvian exports have skyrocketed and both the trade deficit and budget deficit have decreased dramatically. More than one-third of government positions were eliminated, and the rest received sharp pay cuts. Exports increased after goods prices were reduced due to private business lowering wages in tandem with the government.

Paul Krugman wrote in January 2013 that Latvia had yet to regain its pre-crisis level of employment. He also wrote, "So we're looking at a Depression-level slump, and 5 years later only a partial bounceback; unemployment is down but still very high, and the decline has a lot to do with emigration. It's not what you'd call a triumphant success story, any more than the partial US recovery from 1933 to 1936 – which was actually considerably more impressive – represented a huge victory over the Depression. And it's in no sense a refutation of Keynesianism, either. Even in Keynesian models, a small open economy can, in the long run, restore full employment through deflation and internal devaluation; the point, however, is that it involves many years of suffering".

Latvian Prime Minister Valdis Dombrovskis defended his policies in a television interview, stating that Krugman refused to admit his error in predicting that Latvia's austerity policy would fail. Krugman had written a blog post in December 2008 entitled "Why Latvia is the New Argentina", in which he argued for Latvia to devalue its currency as an alternative or in addition to austerity.

Controversy

Main article: Anti-austerity protests

Austerity and economic growth

Austerity protest in Athens, 2011

Austerity programs can be controversial. In the Overseas Development Institute (ODI) 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 tending "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 citizens are forced to repay the debts of their oppressors.

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.

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. Following the announcement of plans to introduce austerity measures in Greece, massive demonstrations occurred 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 29 June 2011. The third round of austerity was approved by the Greek parliament on 12 February 2012 and met strong opposition, especially in Athens and Thessaloniki, where police clashed with demonstrators.

Opponents argue that austerity measures depress economic growth and ultimately cause reduced tax revenues that outweigh the benefits of reduced public spending. Moreover, in countries with already anemic economic growth, austerity can engender deflation, which inflates existing debt. Such austerity packages 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 placed those countries at risk of defaulting in late 2010. According to economist David Stuckler and physician Sanjay Basu in their study The Body Economic: Why Austerity Kills, a health crisis is being triggered by austerity policies, including up to 10,000 additional suicides which have occurred across Europe and the U.S. since the introduction of austerity programs.

In October 2012, the IMF announced that its forecasts for countries that implemented austerity programs have been consistently overoptimistic, suggesting that tax hikes and spending cuts have been doing more damage than expected and that countries that implemented fiscal stimulus, such as Germany and Austria, did better than expected. This data has been scrutinized by the Financial Times, which found no significant trends when outliers like Germany and Greece were excluded. Determining the multipliers used in the research to achieve the results found by the IMF was also described as an "exercise in futility" by Professor Carlos Vegh of the University of Michigan. Moreover, Barry Eichengreen of the University of California, Berkeley and Kevin H. O'Rourke of Oxford University write that the IMF's new estimate of the extent to which austerity restricts growth was much lower than historical data suggests.

On 3 February 2015 Joseph Stiglitz wrote : "Austerity had failed repeatedly from its early use under US president Herbert Hoover, which turned the stock-market crash into the Great Depression, to the IMF programs imposed on East Asia and Latin America in recent decades. And yet when Greece got into trouble it was tried again." Government spending actually rose significantly under Hoover, while revenues were flat.

Debt threshold

In their 2010 Growth in a Time of Debt paper, economists Kenneth Rogoff and Carmen Reinhart reported that among the 20 developed countries studied, average annual GDP growth was 3–4% when debt was relatively moderate or low (i.e., under 60% of GDP), but it dipped to just 1.6% when debt was high (i.e., above 90% of GDP). The "90 percent rule," as Canterbery has called it, is broadly critiqued in his The Rise and Fall of Global Austerity. According to Canterbery, the study was a bombshell heard round the world, or at least from Washington to Brussels. The 90% rule was ignored, and the broader conclusion accepted wholeheartedly. In the short run, it was one of the most influential papers in history. Suddenly, ending federal budget deficits became more important than ending a recession. for at least the next three years, austerity was the catchword of the day. There was a headlong rush to slash spending among many countries, including especially, the United States. The 90% rule was surpassed during what Canterbery dubbed "The Great Recession." Had the researchers been anywhere but Harvard, they perhaps would have been ignored. In April 15, 2013 the findings of the Reinhart-Rogoff paper were shown to be incorrect. Two researchers at the University of Massachusetts published a paper that closely examined the Reinhart and Rogoff database. R & R's data contained data from 20 countries that filled lines 30-49 on the spreadsheet, but the formula that calculated the results relied on lines 30-44. It was the Excel error heard round the world. The second paper changed everything, but political opinions. However, other economists, including Canterbery and Paul Krugman, have argued that it is low growth that causes national debt to increase, not the other way around. In April 2013, the conclusions of Rogoff and Reinhart's study came into question after a coding error in their original paper was discovered by Herndon, Ash, and Pollin of the University of Massachusetts Amherst. They found that after correcting for errors and unorthodox methods used, there was no evidence that debt levels above a particular threshold reduce growth. Reinhart and Rogoff maintain that after correcting for errors, a negative relationship between high debt and growth remains. The debate between Krugman, Reinhart and Rogoff is summarized in Reinhart's open letter to Krugman.

A February 2013 paper from four economists concluded that "Countries with debt above 80 percent of GDP and persistent current-account [trade] deficits are vulnerable to a rapid fiscal deterioration". The statistical relationship between a higher trade deficit and higher interest rates was stronger for several troubled Eurozone countries, indicating that significant private borrowing from foreign countries (required to fund a trade deficit) may be a more important factor than government debt in predicting interest rates.

Federal Reserve chairman Ben Bernanke stated in April 2010 that "Neither experience nor economic theory clearly indicates the threshold at which government debt begins to endanger prosperity and economic stability. But given the significant costs and risks associated with a rapidly rising federal debt, our nation should soon put in place a credible plan for reducing deficits to sustainable levels over time."

Austerity sequence

Further information: Household debt

Several economists have argued that an appropriate strategy when an economy is faced with unusually high private debt levels is initially to exchange private debts for public debts, then cut government debt via an austerity strategy once the economy recovers. Applying an austerity strategy to a struggling economy can be counterproductive according to Keynesian theory described above.

For example, the private sector may become highly indebted, such as when a housing bubble bursts. Housing prices fall while the mortgage obligations remain fixed, leading to "underwater" homeowners unable to consume at sufficient levels to drive economic growth. A banking crisis can result, as homeowner defaults make banks unable to lend or stay in business, which slows the economy and worsens unemployment. These effects can become self-reinforcing, creating a downward economic spiral. This spiral is at the core of the subprime mortgage crisis in the U.S. and the European sovereign debt crisis.

Economist Amir Sufi at the University of Chicago argued in July 2011 that a high level of household debt was holding back the U.S. economy. Households focused on paying down private debt are not able to consume at historical levels. He advocated mortgage write-downs and other debt-related solutions to reinvigorate the economy when household debt levels are exceptionally high.

Economists Joseph Stiglitz and Mark Zandi both advocated significant mortgage refinancing or write-downs during August 2012. This could be financed by the government taking on additional short-term debt as a form of stimulus. The government would borrow at a very low interest rate and create an entity to purchase mortgages, receiving a higher interest rate from the mortgages it refinances. The losses due to mortgage principal write-downs would be shared between the government and financial institutions, with the government losses offset by the interest rate differential.

The International Monetary Fund (IMF) reported in April 2012, "Household debt soared in the years leading up to the Great Recession. In advanced economies, during the five years preceding 2007, the ratio of household debt to income rose by an average of 39 percentage points, to 138 percent. In Denmark, Iceland, Ireland, the Netherlands, and Norway, debt peaked at more than 200 percent of household income. A surge in household debt to historic highs also occurred in emerging economies such as Estonia, Hungary, Latvia, and Lithuania. The concurrent boom in both house prices and the stock market meant that household debt relative to assets held broadly stable, which masked households' growing exposure to a sharp fall in asset prices. When house prices declined, ushering in the global financial crisis, many households saw their wealth shrink relative to their debt, and, with less income and more unemployment, found it harder to meet mortgage payments. By the end of 2011, real house prices had fallen from their peak by about 41% in Ireland, 29% in Iceland, 23% in Spain and the United States, and 21% in Denmark. Household defaults, underwater mortgages (where the loan balance exceeds the house value), foreclosures, and fire sales are now endemic to a number of economies. Household deleveraging by paying off debts or defaulting on them has begun in some countries. It has been most pronounced in the United States, where about two-thirds of the debt reduction reflects defaults." These countries might also benefit from household debt reduction policies involving exchanging private debt for public debt.

Balancing stimulus and austerity

Strategies that involve short-term stimulus with longer-term austerity are not mutually exclusive. Steps can be taken in the present that will reduce future spending, such as "bending the curve" on pensions by reducing cost of living adjustments or raising the retirement age for younger members of the population, while at the same time creating short-term spending or tax cut programs to stimulate the economy to create jobs.

IMF managing director Christine Lagarde wrote in August 2011, "For the advanced economies, there is an unmistakable need to restore fiscal sustainability through credible consolidation plans. At the same time we know that slamming on the brakes too quickly will hurt the recovery and worsen job prospects. So fiscal adjustment must resolve the conundrum of being neither too fast nor too slow. Shaping a Goldilocks fiscal consolidation is all about timing. What is needed is a dual focus on medium-term consolidation and short-term support for growth. That may sound contradictory, but the two are mutually reinforcing. Decisions on future consolidation, tackling the issues that will bring sustained fiscal improvement, create space in the near term for policies that support growth."

Federal Reserve Chair Ben Bernanke wrote in September 2011, "the two goals—achieving fiscal sustainability, which is the result of responsible policies set in place for the longer term, and avoiding creation of fiscal headwinds for the recovery—are not incompatible. Acting now to put in place a credible plan for reducing future deficits over the long term, while being attentive to the implications of fiscal choices for the recovery in the near term, can help serve both objectives."

"Age of austerity"

Further information: United Kingdom government austerity programme

The term "age of austerity" was popularized by British Conservative leader David Cameron in his keynote speech to the Conservative Party forum in Cheltenham on 26 April 2009, in which he committed to end years of what he called excessive government spending.

Word of the year

Merriam-Webster's Dictionary named the word "austerity" as its "Word of the Year" for 2010 because of the number of web searches this word generated that year. According to the president and publisher of the dictionary, "austerity had more than 250,000 searches on the dictionary's free online [website] tool" and the spike in searches "came with more coverage of the debt crisis".

Examples of austerity

• United States, 1921, 1937, 1946
• European countries, 2012
• Argentina, 1952
• Puerto Rico, 2009–2012
• Brazil, 2003–2006, 2015
• Netherlands, 1982–1990, 2003–2006, 2011–2014
• Germany, 2011
• United Kingdom, during and after the two World Wars, 1976-1979, 2011–2014
• Czech Republic, 2010
• Italy, 2011–2013
• Greece, 2010–2015
• Ireland, 2010–2014
• Portugal, 1977–1979, 1983–1985, 2002–2008, 2010–2015
• Romania, Ceaușescu's 1981–1989 austerity, 2010
• Japan, 1949 American Occupation, 2010
• Spain, 1979, 2010–2014
• Latvia, 2009
• Palestinian Authority, 2006
• Nicaragua, 1997
• Canada, 1994
• Cuba, 1991–1999
• Mexico, 1985
• Israel, 1949–1959

See also

• Functional finance
• Planned shrinkage
• Programme commun - French reform programme cancelled by 'Austerity turn'
• Trickle-down economics

External links

• The Austerity Zone: Life in the New Europe – videos by The New York Times
• Socialist Studies Special Edition on Austerity (2011)
• Panic-driven austerity in the Eurozone and its implications Paul De Grauwe, Yuemei Ji, 21 February 2013
• NYT Review of Books – Paul Krugman – How the Case for Austerity Has Crumbled – June 2013
• IMF Working Paper-Olivier Blanchard and Daniel Leigh-Growth Forecast Errors and Fiscal Multipliers-January 2013
• How Austerity Kills. The New York Times. 12 May 2013.
• The Austerity Delusion; Why a Bad Idea Won Over the West May/June 2013 Foreign Affairs
• Video: Richard Koo debates Kenneth Rogoff about the need for austerity, Institute for New Economic Thinking inaugural conference, 22 April 2010
• "Debt may be 'Schuld' in German, but it's 'belief' in Italian and 'faith' in English" Interview with Mark Blyth Science Portal L.I.S.A., 26.01.2015
• Austerity’s Greek Death Toll: Study Connects Strict Measures to Rise in Suicides. Truthdig. February 4, 2015.
• Hundreds of mental health experts issue rallying call against austerity. The Guardian. April 17, 2015.
• Juice Rap News (April 2015). The EuroDivision Contest, a satire/parody of austerity
• Is austerity the new normal? A look at Greece and France, Tony Cross
• Life Under Austerity. Jacobin. July 12, 2015.