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Austerity and How to Avoid It

Austerity is a sustained period of harmful spending cuts, primarily to entitlements, in combination with tax increases. This combination, which drains the private sector of resources without increasing economic activity, springs from a government’s wrestling with a budget deficit. The deficit, in turn, is caused by spending programs that promise more than what taxpayers can afford. In an austerity response to the deficit, government executes repeated cuts in spending and a series of tax increases. Each new round of policy measures is executed with increasing urgency. Government gives itself less and less time to devise a long-term proactive strategy to restore economic growth and reduce unemployment and the deficit.

Recently Greece and Spain have tried austerity in response to their crises. Neither country is showing signs of improvement, either in their government finances or their GDP. On the contrary, several European countries, led by Greece and Spain, are in fact worse off now than before they resorted to austerity.

America is rapidly catching up with Europe. Our federal deficit is unsustainable and the lack of Congressional action over the past couple of years has only raised the urgency level of the problem. While it is not possible to use one country as a complete template for how another country will evolve economically, it is nevertheless important to recognize that America shares its macroeconomic system with debt-ridden countries like Greece and Spain. The mere size of our economy gives us a larger buffer zone, so to speak, against the stress caused by government deficits and debt, but that only gives Congress more time to deal with the problem before we get caught in the downward spiral that leads to austerity. Our “cushion” does not give us a pass on solving our deficit problem.

It is also worth pointing out that Greece and Spain are not as small as their GDP might indicate. They are both part of the euro, the dollar’s closest currency competitor. When the euro was created there was a widespread consensus among economists that by its very size this new currency would provide a credit shield of unshakeable proportions for small EU states. Needless to say, the debt crisis in southern Europe over the past couple of years has proven that notion wrong.

America still has options on how to handle its deficit, but doing nothing is not one of them. Remarkably, this is the strategy suggested by, e.g., the Democrats in Congress in their response to the 2013 Republican budget. As this video explains, there is only one way to solve a budget crisis, and it is not by means of austerity.

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