Austerity Measure
The growth path of an economy does not follow a smooth trajectory. It is composed of a number of short-term and long-term fluctuations. The magnitude and duration of such fluctuations are varied. The government uses its two important tools, the fiscal policy and the monetary policy to smoothen out this jagged path to some extent. During periods of boom, that is, when the economy experiences high rate of growth with low unemployment rate and high income, the government follows a contractionary fiscal and monetary policy. In times of slump when the economy is under a phase of deceleration in growth with low output and employment, the government follows expansionary fiscal and monetary policy to boost the growth of the nation.
The tools of fiscal policy include tax rates, subsidies and government expenditure. The monetary tools are the rate of interest and open market operations that alter the money demand and supply in the economy to bring a change in output and employment. In times of fiscal expansion, the government reduces the taxes and increases government expenditure. The reduction in taxes increases consumption expenditure and boosts production so that the GDP increases and more employment is generated. In times of fiscal contraction the government increases the tax rates and reduces government expenditures. The consumption expenditure and total production declines, and unemployment increases. The fiscal policy should be matched with an appropriate monetary policy. The monetary expansion is brought about through the reduction in the rate of interest or increasing purchases of bonds by the central bank that pumps in more money into the economy. A reduction in the rate of interest increases the demand for money and induces investment. The increased investment boosts growth. In times of monetary contraction the central bank increases the rate of interest so that money flow in the economy is reduced.
We know that the government budget is the net of government revenue and expenditure. When the government provides a fiscal stimulus, the expenditures are greater than the revenue as taxes are low and expenditures high. This leads to a budget deficit. The deficit is a way of providing an impetus to the growth of the economy. When the government follows fiscal contraction the revenue is more than the expenditure as taxes are high and expenditure low. This generates a surplus. When the government provides a fiscal stimulus for a long period of time, a considerable amount of deficit is generated. When the deficit reaches alarming proportions the credibility of the government is at stake. The debt position becomes a matter of concern. The government has to follow austerity measures to recover the deficits. Austerity measures are the fiscal contraction to recover the government from the high deficit position.
In times of fiscal contraction that is, when the government follows austerity measures, the expenditures are low and taxes high. This position can actually prove dangerous for the economy. With the fall in the government expenditure and high tax rates, the consumption expenditure is low, production is slowed down. The slow down increases the level of unemployment and reduces the GDP to a large extent. With the increase in unemployment and the fall in income the government revenue actually falls and the expenditure increases as the government has to provide more social security benefits to the unemployed and the low income groups.
So, severe austerity measure cannot improve the state’s debt position. In times of severe austerity measure the central bank has to follow monetary expansion to give a support to the falling GDP. The reduction in the rate of interest increases investment and can improve output and employment. But if the austerity measure is continued for a long period the scope of monetary expansion is also reduced. The rate of interest might be brought to a quite a low level and cannot be reduced further. This situation brings the economy to a precarious condition. So austerity measures cannot be continued for a long time when the economy is facing retardation in growth. Only when the economy is going through a phase of accelerated growth with very low unemployment rate, the austerity measures can improve the deficit in the budget.
Works Cited
Mankiw, G. (2013). Macroeconimcs. Macmillan.
