The economics of austerity

Konzelmann, Suzanne J. (2012) The economics of austerity. Working Paper. Centre for Business Research, Cambridge, UK.

Abstract

The 2007/8 financial crisis has reignited the debate about austerity economics and revealed that it is a highly contested yet poorly understood idea. This article locates the debate in its historical context, tracing it from the early 18th and 19th century Classical debates, which focused mainly on the means by which fiscal deficits should be financed. As capitalism evolved, so did ideas and theories about the economics of austerity. Following World War One, concerns about high levels of government debt produced the 1920s ‘Treasury view’ – that government deficits are economically damaging and austerity is required to rein them in. During the 1930s Great Depression, when unemployment was the main concern, this perspective was challenged by the ‘Keynesian view’ – that government deficits could be economically beneficial during the slump, when the private sector was unable to generate sufficient effective demand to pull the economy out of depression. From this perspective, austerity was the policy prescription for the top of the business cycle, to prevent the economy from overheating and igniting inflation. The ‘stagflationary’ crises of the 1970s challenged this view; and during the decades preceding the 2007/8 crisis, austerity was considered to be a policy for the bottom of the business cycle, when the excesses of a bubble-inflated boom had been revealed by its collapse. In the aftermath of the 2007/8 financial crisis, however, austerity no longer has the economic objective of macroeconomic stabilization. Instead, it has become the objective itself – demanded by actors in the international financial markets as evidence that governments are serious about managing their deficits and paying back their debts, thereby protecting the financial interests of investors in sovereign debt. However, if austerity undermines economic growth – as it is doing at present – markets are unlikely to remain loyal to those countries suffering the effect. It is therefore important that policy-makers and political leaders learn the lessons of the 2007/8 financial crisis with regard to the economics of austerity – before it is too late.

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