Economics, 3rd Edition

AUSTERITY POLICIES – TOO FAR TOO QUICKLY?

A feature of the sovereign debt crisis has been the adoption by a number of countries of austerity 

 programmes – significant cuts in public spending, tax rises and structural reforms. In principle, it is easy 

to say that if a country is borrowing too much and has debt problems that it must cut its spending and 

raise more revenue. The practical implications of this policy are more complex. Not only are the people of 

the country where austerity programmes are implemented likely to be severely affected, if such policies 

are adopted during a period of weak economic activity the effects are likely to be that national income 

will decline and unemployment rise. A deep and lasting recession in Greece, for example, means that the 

prospects for any growth-led recovery looked bleak; if a country like Greece is experiencing GDP growth 

rates of 

−7 per cent then the chances of generating tax revenue to pay off debt and invest in improving the 

economy are slim. Firms are more likely to fail in such an environment and so corporate borrowing comes 

under pressure as the risk of default is higher. If corporate bond rates rise then firms will not be able to 

afford to borrow which further hampers the productive capacity of the economy. The periphery countries 

find themselves in a very difficult situation.

The UK is also experiencing similar problems. The Coalition Government pledged to cut the deficit and 

borrowing when it came into office in 2010. Cuts in public spending and tax increases have led to weak 

economic growth and the economy going back into recession. With the economy performing so badly, the 

government has found it difficult to see short-term improvements in public finances and re-emphasized 

the need to stick with its policies for the long-term good of the country. There are many economists who 

agree that sorting out the UK’s debt and deficit problem is important but there are also those that argue 

that the extent of the austerity measures in a time of weak global economic growth is too much too 

quickly and have argued that policies focusing on growth are necessary.