If you are a parent and you pay monthly pocket money of $500 to your child but due to some financial problem you reduce that pocket money of your child to $200 than in layman terms this is called cutting of expenditure by the parents due to weak financial condition but in economic terms this is called austerity. Austerity refers to cut in government spending by the government of the country due to recession or weak economic condition of the nation, in the past decade since financial crisis of 2008 world has seen only expansionary monetary policies of the governments across the world but slowly governments across the world are thinking of adopting austerity measures in their economies. In order to understand more about this concept, one should look at the advantages and disadvantages of austerity –
Advantages of Austerity
Helpful in Reducing Budget Deficits
The first and foremost advantage of austerity measures is that it is helpful in reducing the budget deficits of the government because when the government reduces government spending than in terms of budget it will be better off assuming that revenue of the government remains same. Hence in the above example in case of pocket money, you will be able to save $300 per month due to cut in pocket money expense of your child which in turn will decrease your spending by $300 the same thing happens when the government reduces its spending.
Better Financial Prudence
Another benefit of this measure is that it helps in better financial prudence on the part of the government because when the government is spending without any restriction the government departments also spend recklessly which in turn results in government spending on those projects or schemes which are not necessary and beneficial for the economy. Hence in the above example if your child education-related expense is $150 and rest is entertainment, parties and miscellaneous expenses than on cutting the pocket money he or she will be able to spend only $50 instead of $350 on other expenses resulting in more prudence on the part of the child while managing various expenses.
Helpful in Reducing Inflation
When the government spends money it results in more money in the economic system which in turn can give to rise to inflation because the supply of goods and services is limited and when money chases those limited products and services it will result in an increase in inflation. In simple words, if production in the country does not increase due to increased government spending than it will result in nothing but increased inflation rate which in the long run can prove to be a disaster for the economy.
Disadvantages of Austerity
Liquidity Crisis
The biggest limitation of austerity is that in times of economy slowdown or recession if government adopts this measure by reducing its expenditure than it can lead to liquidity crisis in the financial system which in turn can have contagion effect not only on the financial markets but the whole economy which in turn can further aggravate the economy slowdown.
Lower Aggregate Demand
When country is facing recession or lower economic growth than demand in the economy is not that much and if government also reduces its demand by cutting its spending than it can lead to lower aggregate demand, which in turn can lead to vicious cycle of lower demand which in turn will lead to lower production by the companies resulting in lower employment opportunities for people of the country which will lead to lower income resulting in further drop in demand.
Unpopular Decision
Another demerit of austerity is that it is an unpopular decision because in case of democracies ruling party will need strong political will to take the decision of cutting its spending in times economic slowdown and that is the reason why you seldom see any ruling party implementing these measures before elections even if these measures are good for the economy in the long run.
As one can see from the above that austerity has pros as well as cons and that is the reason why any government thinking of going ahead with austerity measures should carefully read above points and then decide whether to go ahead with these measures or not.