What is the "Austerity"?
Austerity refers to the government’s reduction of spending to lower its deficit. Austerity measures, which usually involve wage cuts and tax hikes, are implemented by the government to ensure their creditors will pay back their loans.
Austerity measures, considered harsh implementations of economic policy, are intended to reduce the government's budget deficit. These policies can take many forms, such as reducing government spending as well as increasing taxes.
Because austerity measures are considered to be components of contractionary fiscal policy, they are enacted only in desperate times, most often when a government defaults on its debt.
According to the World Bank, this threshold of default is a ratio of 77% of public debt-to-GDP. When a government increases its taxes, it generates more revenue. When a government reduces its spending, it has more money to pay down its debt.
Reducing government spending can take on many forms. It usually results in cutting non-essential programs. This includes cutting or freezing the wages of government employees, cutting back on government programs, such as programs for veterans, the homeless, and national parks, a freeze on hiring, and a freeze on pensions.
Historical Austerity Measures
The United States implemented austerity measures during the depression that occurred from 1920 to 1921. From that period, unemployment jumped from 4% to 12%, and gross national product (GNP) declined by 17%.
To combat this financial decline, President Harding implemented austerity measures. Harding cut spending by 50%. He cut it from $6.3 billion in 1920 to $3.2 billion in 1922. He cut taxes by 40%. Tax revenue went from $6.6 billion in 1920 to $4 billion in 1922.
Cutting taxes is meant to spur the economy by increasing consumer spending. By 1922, the unemployment rate was down to 7.6%, and in 1923, it was 3.2%.
Recent Example of Austerity Measures
The austerity measures taken in Greece in 2013 during its debt crisis are one of the most recent examples of austerity measures. Greece greatly suffered from the Great Recession, which saw its unemployment rate increase from a low of 7.7% in 2008 to 28% in 2013.
After austerity measures were implemented in Greece, the unemployment rate started to drastically decrease, where it stood at 15% before the 2020 crisis.
Greece's economic problems started during the financial crisis when it was about to default on its debt payments to the European Union (EU), which would have caused financial chaos in the Union itself. To prevent Greece from doing so, the EU made bailout payments to Greece to continue making its payments.
Greece's economic issues arose because it was spending more than it was bringing in. In 2009, its budget deficit was greater than 15.4% of its gross domestic product (GDP). It simply was not bringing in enough money to cover its spending, including furnishing its debt. As part of the bailout money, the European Union required Greece to implement austerity measures.
The austerity measures implemented were far and wide. First and foremost, the EU demanded that Greece overhaul its tax structure. This involved rebalancing the tax burden, simplifying the tax code, eliminating special tax exemptions and preferential treatment, and fighting tax evasion.
Other austerity measures included reducing the standard wages for employees by an average of 17%, cutting pensions by rates between 40% to 15%, depending on the age of the individual and the amount, new levies on real estate, reducing government employees by 150,000, and many other austerity measures.
Although the austerity measures helped Greece somewhat, it is hard to argue that they have been completely beneficial. Greece's unemployment rate is still very high; its ratio of government spending to GDP was 46.2% in 2019, down only slightly from 50.68% in 2015, and is expected to be 46.72% in 2025.