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Austerity Measures: Yes or No?

June 16, 2010

The usage of word “austerity” is on the rise these days in all kinds of media, thanks to the global recession. You read any economy related news and chances are you will come across the word austerity. That explains how the word made to the top 50 list of words searched by NY Times users in its dictionary feature to understand the meaning (it’s ranked No. 4 in the list). So let’s see what it means. According to Oxford Dictionary of Difficult words, Austerity means

noun– sternness or severity of manner or attitude

  • extreme plainness and simplicity of style or appearance
  • conditions characterized by severity, sternness, or asceticism
  • difficult economic conditions created by government measures to reduce a budget deficit, esp. by reducing public expenditure

In the current grim economic scenario, the word austerity relates to stern economic steps taken by governments in form of increased taxes and reduced benefits to overcome budget deficit. Economic crisis has hit all the countries badly including US and Euro zone and there has been debate going on whether austerity is the way to go. European economies have already started taking austerity measures and in US debate is going on.  The countries which are taking austerity measures include Greece, Spain, Italy, Hungary, UK and even France and Germany as a pre-emptive measure and also to be a role model to other less regulated European economies. So how countries are doing it? Salary freezes, wage reductions, reduced reitirement benefits, reduced pensions, increased taxes, higher retirement ages  are few of the measures taken by these governments to reduce the deficit, which ofcourse has met with serious opposition from their citizens (picture above shows protest in Greece). Greece is being bailed out by IMF and other European countries, so these austerity measures were imposed as conditons of bailout and they are supposed to reduce their deficit from 13.6% of GDP to close to 2.6% by 2014.You can read in detail about what measures other countries are taking in this CNN article.

I don’t know anything about economics and seeing economies of countries falling one after the other like a deck of cards, I doubt if any of these governments understood the dynamics of economics clearly. Whenever I try to understand what’s going on in the fiscal world, I turn to Nobel Laureate Dr Paul Krugman’s blog to get some basic understanding. In his recent posts he has discussed that he does not support this austerity-mania in Europe and more thoughts need to be put into it. He also suggests that US should avoid falling into this austerity frenzy.

Let me start with the budget arithmetic, borrowing an approach from Brad DeLong. Consider the long-run budget implications for the United States of spending $1 trillion on stimulus at a time when the economy is suffering from severe unemployment.

That sounds like a lot of money. But the US Treasury can currently issue long-term inflation-protected securities at an interest rate of 1.75% . So the long-term cost of servicing an extra trillion dollars of borrowing is $17.5 billion, or around 0.13 percent of GDP.

And bear in mind that additional stimulus would lead to at least a somewhat stronger economy, and hence higher revenues. Almost surely, the true budget cost of $1 trillion in stimulus would be less than one-tenth of one percent of GDP – not much cost to pay for generating jobs when they’re badly needed and avoiding disastrous cuts in government services. [Paul Krugman]

It makes sense to me now why stimulus is needed for strengthening the economy in the long run  rather than mindlessly reducing spending, especially for economies like US, UK and Germany where the investors have confidence and offer securities at low interest rate. While for countries like Greece, Spain, Ireland where investors have lost confidence austerity might be the way to go, even that is debatable. The whole idea of world economy is based on belief and confidence in each other and if a country spends for bolstering the confidence and strengthening of the economy, it should be ok, although carefully planned and regulated spending is the need of the hour. Mindless spending needs to be stopped, case in point being the spending by Greece govt on it’s employees; they were given 14 months salary and 75% of their money was spent on supporting Govt staff!!

So that was the word of the day- Austerity!

Picture: Caption-Greeks on streets again; demonstrating against IMF austerity measures— by Flickr user apostolosp . Used under Creative Commons License.

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