What is Austerity?
Austerity refers to the situation of a government or nation adopting severe policies to reduce the effects of an economic crisis. Austerity measures are implemented to prevent debt crises. These help a country to monitor government spending, restrain it, and introduce new policies in the annual budget.
Fiscal risks like economic crises are often associated with Higher Unemployment rates and low development. To deal with the consequences, governments take actions such as increasing taxes and cutting down discretionary spending. However, an increase in tax during a stable economic condition is not an austerity measure.
How Austerity Works
When the ratio of public debt to GDP exceeds the level of fiscal revenues, governments face financial instability and large fiscal deficits. This situation arises from excessive public spending or borrowing, which increases the default risk on sovereign debt. Hence, creditors demand higher risk premia on lending to such governments. To restore fiscal sustainability and market confidence, governments may adopt austerity measures.
Austerity indicates a reduction in the fiscal deficit, either by cutting public expenditure or raising taxes. By doing so, governments signal their commitment to fiscal discipline and debt repayment, which may lower the interest rate on their debt. However, this effect may be conditional on other factors.
For Example, in case of Pakistan has received several bailout packages from the International Monetary Fund (IMF) over the years, each with strict austerity measurements. In 2019, Pakistan agreed to a three-year, $6 billion bailout package from the IMF in exchange for tough austerity measures. These included increasing electricity and gas prices, easing the currency, increasing interest rates, slashing subsidies, expanding the tax base, and reforming state-owned enterprises. Also, in 2021, Pakistan received another $1.1 billion allotment from the IMF after levying unpopular austerity measures such as increasing fuel prices, lowering public sector salaries, and cutting development spending.
The explanation behind these austerity measures is to lower the budget deficit, curb inflation, enhance the balance of payments, and enhance the productivity and competitiveness of the economy. However, these measures also have negative social and political impacts, such as increasing poverty, unemployment, imbalance, and public discontent. I.e., the austerity is not limited to the economic but also social and political