AS Macro Key Term: Fiscal Austerity

Fiscal austerity is a term in common use in the media at the moment. It refers to decisions by a government to reduce the amount of government borrowing (i.e. cut the size of a fiscal deficit) over a period of years. Fiscal austerity normally involves a combination of measures including increases in the overall burden of taxation and cuts in either the real level or growth of government spending on state-provided goods and services.

Fiscal austerity is in the news in the UK because of the Coalition Government’s plans top eliminate the structural budget deficit over the course of the current Parliament. In their Coaltion document they claim that:

1/ We will accelerate the reduction of the structural budget deficit over the course of a Parliament 2/ The main burden of the budget deficit reduction will be from reduced spending rather than increased taxes.

Data from Timetric.

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OECD Economic Outlook Database (version 88) from Timetric

Supporters of the Coalition’s plans to squeeze the deficit through a policy of fiscal consolidation argue that:

a) High government debt threatens the UK’s financial stability and our AAA credit rating
b) Higher public sector debt and higher future taxes might crowd-out the private sector and reduce the strength of the recovery over the next cycle
c) It is inequitable to leave future generations with excessive levels of debt to repay
d) There are doubts about the size of the fiscal multiplier and effectiveness of fiscal stimulus policies in boosting demand and output
e) Tight fiscal policy now may help to restore confidence among businesses and the financial sector

Critics of the Coalition - many of whom are arguing from a Keynesian perspective - argue that:

a) UK Government bond yields are low – it is sensible for the government to borrow now to boost demand when the private sector remains weak
b) Deep cuts in government spending will derail a fragile recovery and another recession will make the fiscal deficit worse - this needs to be avoided
c) The government should let monetary policy (in the hands of the Bank of England) do the main job of controlling inflation – don’t slash and burn public spending
d) There are doubts about resilience of the private sector and whether it will be able to create enough new jobs to absorb the hundreds of thousands of jobs that will be lost in the public sector
e) Tough fiscal austerity provides an illusion of prosperity - there is little evidence that it boosts confidence. Instead millions of people will see their real living standards affected by the squeeze on state spending and the rise in taxation

Data from Timetric.

To view this graph, please install Adobe Flash Player.

OECD Economic Outlook Database (version 88) from Timetric