Is austerity necessary?

uk-national-debt

Since 2010, the UK economy has been dominated by spending cuts and the desire to run a budget surplus as soon as possible. In the political world, the government deficit is often portrayed as the source of many economic ills and eliminating the deficit one of the highest macro objectives. However the government deficit (see: …

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What is Austerity?

Readers question: What is Austerity?

Simple definition of Austerity

  • Austerity involves policies to reduce government spending (or higher taxes) in order to try and reduce government budget deficits – during a period of weak economic growth.

Austerity policies are often associated with higher unemployment and lower economic growth.

uk-net-borrowing-budget-deficit

Austerity policies (and automatic stablisers) have reduced levels of government borrowing since 2010.

More complex points and definitions of austerity

The term austerity is more likely to be used when government spending cuts and higher taxes occur during a recession or period of very weak economic growth. Austerity implies that spending cuts and tax increases are highly likely to have an adverse impact on aggregate demand and economic growth. For example, if the government increased taxes during an economic boom, this would probably not be referred to as austerity. But, if the government cut spending during a period of negative growth, this would be referred to as austerity policies.

What constitutes actual austerity?

  • A simple definition of austerity implies actual spending cuts. However, some may refer to austerity policies – even if there has just been a limit in the growth of government spending. For example, in the past 10 years, government spending may have increased on average by 3% in real terms. If the government now freezes public sector spending, this may be termed ‘austerity policies’ – because government spending is not increasing at the same rate as previously.

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Is Austerity Self Defeating?

Question from the Economist. – It is easy to understand the case that European austerity is self-defeating. But it is also easy to see that one cannot run large deficits year after year without limit and that some countries (Greece, Portugal) have exhausted the willingness of private investors to finance them. Is Austerity self-defeating? Austerity …

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Economic impact of welfare freezes

Readers Question: What is the economic impact of proposed welfare benefit freezes proposed by Chancellor, Mr Osborne?

Mr Osborne has proposed a welfare freeze, worth £3 billion of savings over two years. This benefit freeze includes Jobseeker’s Allowance, Income Support, Child Tax Credit and Working Tax Credit, Child Benefit and Employment Support Allowance (paid to those judged capable of work). It does not include pensions, disability benefits and maternity pay.

The Treasury said that about 10 million households would be affected, roughly half of which are working.

The freeze will raise around £1.6bn in 2016/17, rising to around £3.2bn a year in 2017/18.

An argument for freezing welfare benefits is that it will help reduce the budget deficit and also – since 2007, average earnings (+17%) have been rising at a slower rate than working-age benefits (+22%.)

Economic effects

Aggregate Demand (AD) / economic growth. Welfare freezes will (ceteris paribus) reduce consumer spending, and lead to lower aggregate demand. It is an example of deflationary fiscal policy. It will be quite significant because people receiving welfare benefits have a high marginal propensity to consume because, on low incomes, they don’t have the luxury of saving – therefore, lower welfare benefits will directly lead to less spending in the economy.  Welfare freezes will also contribute to a decline in consumer confidence because it will be a visible reminder of economic hardship. Combined with other spending cuts of up to £24bn, there is still scope for these planned spending cuts to derail the economic recovery and cause lower growth or even a future recession.

However, the strength of the recent recovery suggests the UK may be in a better position to absorb austerity than a few years ago. Also, the chancellor can rely on the Bank of England to maintain a very loose monetary policy, which will help to offset the impact of this deflationary fiscal policy.

However, we still don’t know the position of the economy in a couple of years. there is evidence that the recovery still is unbalanced with low productivity growth and low real wage growth making the economy still vulnerable. Continued recession in Europe could  also act as a drag on the UK economy; it is possible that these commitments to spending cuts could hold back economic growth, that even monetary policy can’t overcome.

Deficit reduction. The spending cuts will contribute £3bn to saved spending, helping to reduce the budget deficit. However, it is still a small % of the current budget deficit (£93bn). Also, the reduction in deficit may be less than planned because it will cause a fall in tax revenues (e.g. less VAT receipts from lower spending) and also lower economic growth from the austerity measures.

Some economists argue that deficit reduction is essential and there is no alternative but to cut spending. They hope that cutting the deficit will reassure markets and business about the long-term strength of the economy. Other economists argue that recent evidence suggests people don’t gain confidence from austerity – but actually the opposite. (see: Confidence fairy)

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Advice for giving an economics presentation on austerity

Readers Question: I have to visit the college I went to and give 5-10 min talk to A2 Economics students about anything economics related, preferably macro-economics.. something going on in the economy. Suggestions? Giving a presentation on economics can be a daunting thing. I often ask students (at this time of the year) to come …

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The UK’s weak recovery – What counts as success these days?

On the day Spain, announced its unemployment rate had increased to a truly staggering 27%, many see the UK’s anaemic growth rate of 0.3% in Q1 2013 as a ‘success’. But, it is worth noting UK real GDP is still considerably below its 2008 peak. Dataset ABMI at ONS When you look at GDP like …

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Italy hopes to leave austerity behind

After a rather lengthy post on evaluating EU fiscal rules, a more immediate and simple political criticism of the EU’s general austerity policies from Mr Bersani of the Italian Democrats (Pd). The new Italian political leader has argued: “We must leave the austerity cage,” “A change of course is absolutely necessary given that five years …

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