Austerity

Austerity is a set of government policies that reduce a budget deficit by cutting public spending, raising taxes, or both. Its supporters usually call it fiscal consolidation and present it as a way to restore the sustainability of public finances, reassure lenders and keep borrowing costs down. Its critics use the word to describe cuts that they argue deepen recessions and fall hardest on poorer households.

Austerity is one possible stance of fiscal policy, the opposite of a fiscal stimulus. It is often a condition of emergency loans from the IMF or regional bodies, and it is closely linked to debates about the national debt, the size of the fiscal multiplier and the role of the state in the economy.

Imagine a family that has been living on its credit card and is now paying high interest each month. It decides to cancel holidays, eat out less and take on extra work so that it can pay the card down. That is austerity at home, and it usually works for one family because its spending cuts do not affect its own income.

A whole country is different. When a government cuts spending, the money it stops paying was someone else's wages or sales, so incomes elsewhere can fall too. Whether austerity shrinks debt or simply shrinks the economy depends on how strong that knock-on effect is, and that is exactly what economists argue about.

Governments have cut spending to balance their books for as long as they have kept accounts, but the modern debate is shaped by several episodes.

• The 1930s. Spending cuts in Germany under Chancellor Brüning and the Gold Standard-era budget orthodoxy in Britain and the United States are widely blamed for deepening the Great Depression.
• Structural adjustment. From the 1980s, IMF and World Bank lending to developing countries often required deficit reduction as part of structural adjustment programmes, associated with the Washington Consensus.
• The euro crisis. After the 2008 financial crisis, Greece received its first bailout from euro area governments and the IMF in May 2010 in return for deep cuts; Ireland, Portugal and Cyprus followed with programmes of their own. Greek GDP fell by roughly a quarter between 2008 and 2013.
• The United Kingdom. The coalition government elected in 2010 set out a multi-year deficit-reduction plan weighted towards spending cuts, especially to local government and working-age welfare.

Advocates argue that high debt raises sovereign risk and interest costs, can lead to crowding out of private investment and leaves no room to respond to the next crisis. In the 2000s economists Alberto Alesina and Silvia Ardagna argued that consolidations based mainly on spending cuts were sometimes followed by growth, because they boosted confidence and lowered interest rates, a claim labelled "expansionary austerity". A 2010 paper by Carmen Reinhart and Kenneth Rogoff reported that growth tended to be lower when public debt exceeded about 90% of GDP, and it was widely cited in support of cuts. Some proponents also invoke Ricardian equivalence: if households expect lower future taxes, they may spend more today.

Critics, many of them in the Keynesian tradition, argue that cutting spending in a slump reduces aggregate demand, raises unemployment and can even push the debt ratio up because GDP shrinks faster than debt.

• Multipliers. A 2013 IMF working paper by Olivier Blanchard and Daniel Leigh found that forecasters had underestimated fiscal multipliers during the early euro-crisis years, so consolidation did more damage to growth than expected.
• The 90% threshold. In 2013 Thomas Herndon, Michael Ash and Robert Pollin found a spreadsheet error and other choices in the Reinhart–Rogoff data; corrected figures showed slower growth at high debt but no sharp cliff. Reinhart and Rogoff acknowledged the coding error but defended their broader findings.
• Distribution. Studies of the UK and euro-area programmes found that cuts to benefits and public services hit lower-income households, people with disabilities and some regions harder, adding to concerns about inequality and poverty.

The weight of evidence suggests that timing matters. Consolidation tends to be less costly when the economy is near full capacity, when the central bank can cut interest rates to offset it, and when the country controls its own currency. It tends to be most damaging in a deep recession, at the zero lower bound, or inside a monetary union such as the eurozone where the exchange rate cannot adjust.

After the pandemic spending of 2020–2021 and the rise in interest rates from 2022, many governments again face pressure to reduce deficits. The EU's reformed fiscal rules, in force since April 2024, require high-debt members to follow multi-year expenditure paths, and IMF programmes in countries such as Pakistan, Egypt and Argentina include primary balance targets. Supporters describe these as necessary repair; opponents argue that cuts to investment and social spending store up problems for the future. The debate is also tied to wider arguments about neoliberalism and the proper size of the public sector.

• International Monetary Fund: Fiscal Monitor
• NBER: Large Changes in Fiscal Policy: Taxes Versus Spending (Alesina and Ardagna)