Austerity: Cure, Cause — or Just Rebranded?

Automatic stabilisers. In a recession tax receipts fall (lower incomes, profits and spending) and welfare spending rises (more unemployment). The cyclical deficit balloons without any government decision. Bank bailouts added further pressure.

Debt must be continually refinanced. If yields rise, every new gilt issued is more expensive, so debt interest grows and squeezes other spending. Rising yields can also push up mortgage and business borrowing rates across the economy, as the UK saw after the September 2022 mini-budget.

Greece uses the euro, so it had no central bank of its own to buy its bonds or let its currency depreciate. The UK borrows in its own currency, has its own central bank (which was buying gilts through QE), and its debt had a long average maturity. The risk of a Greek-style buyers' strike was therefore much smaller.

Partly ideological (a preference for a smaller state) and partly based on research suggesting spending-based consolidations were more durable and less damaging to growth than tax-based ones. Tax rises are also highly visible to voters, while spending cuts can be spread across services.

Social care is the biggest part of council budgets and was close to protected. Because the largest item barely fell, the overall average stays relatively modest, even though smaller services were cut by half or more.

Health is the public's top priority, demand rises every year with an ageing population, and cuts would be highly visible (waiting lists, A&E). Protecting it was politically essential — but it meant deeper cuts elsewhere to hit the same total.

They are discretionary (no legal duty), their users have little political voice, and the costs of cutting them — worse outcomes for children, higher crime, more pressure on social care — appear years later, often in other budgets.

It is politically easy: delaying a road or a school rebuild causes no immediate job losses or visible service cuts. But public investment raises the economy's productive capacity, so cutting it shifts LRAS less far to the right in future — damaging long-run growth and the future tax base.

Many new jobs were low-paid, part-time, self-employed or zero-hours, and productivity growth was very weak. Firms took on cheap labour rather than investing in capital. Without productivity growth, sustained real wage growth is not possible.

Cutting preventative services (social care, youth services, public health) can shift costs elsewhere: elderly patients stay longer in hospital because care packages are unavailable, which raises NHS spending. This is a "false economy" — a saving in one budget creating a larger cost in another.

If prices rise and the benefit stays the same in cash (nominal) terms, its real value falls. Inflation does the cutting quietly — a classic way to reduce spending without announcing a headline cut.

Future generations inherit the infrastructure as well as the debt. If a school or railway is not built, they lose the benefit and may face higher repair or rebuilding costs later, while the debt saving may be small, especially if borrowing costs were low.

Older voters turn out to vote in much higher numbers. Governments also argued that pensioners cannot easily increase their income through work. The political economy of austerity often reflects who votes, not just economic need.

Young people who start their careers unemployed lose skills, experience and confidence — a "scarring" effect that lowers lifetime earnings and productivity. This is a form of hysteresis: it reduces future potential output and future tax revenue.

The ratio has two parts. Austerity reduces the numerator (debt) by a little but, via the multiplier, may reduce the denominator (GDP) by more. If GDP falls proportionally faster than debt, the ratio rises.

In a recession there is spare capacity, so lost demand translates straight into lost output rather than lower prices; more households are credit-constrained, so they spend any income change (high MPC); and the central bank may be unable to cut rates to offset it.

At 5%, the Bank of England can cut rates to stimulate consumption and investment, replacing some of the lost government demand. At 0.5% that tool is largely exhausted, so fiscal tightening passes through to output far more fully.

One country can offset weaker domestic demand by exporting more. If all its trading partners (e.g. the Eurozone after 2010) are tightening at the same time, export demand falls too — there is no external escape route.

Unlike spending on teachers or roads, interest payments buy no new goods or services today. Every pound paid to bondholders is a pound that could have been spent on public services, investment or tax cuts.

While Bank Rate was near zero, the Bank earned more on its gilts than it paid on reserves, so profits flowed to the Treasury. When rates rose, that reversed: the government effectively swapped long-term fixed borrowing for borrowing at Bank Rate, which became expensive.

It kept borrowing off the headline figures, allowing investment without appearing to increase debt. But the private sector borrows at higher interest rates than the government, and inflexible 30-year contracts locked in payments, so the total cost to taxpayers was usually higher.

Investment raises the economy's productive capacity and future tax revenue. Cutting it saves money now but lowers future growth, so the debt-to-GDP ratio may end up higher than if the investment had gone ahead.

Large unfunded tax cuts meant more borrowing and more demand at a time when inflation was already above 10% and the Bank was raising rates. Markets expected higher inflation, higher interest rates and more debt, so they demanded higher yields to hold gilts.

Higher rates raise the government's debt interest bill and the cost of new borrowing. To stay within its fiscal rules, the government may then need spending cuts or tax rises — so tight monetary policy can push fiscal policy tighter too.

Tighter fiscal policy reduces aggregate demand, so the Bank does not need to raise interest rates as far to bring inflation back to target. That means lower mortgage costs and less damage to investment than relying on monetary policy alone.

Tax rises are visible and immediately felt by voters, often breaking manifesto promises. Efficiency savings sound costless — the implication is that money was being wasted — so they are much easier to sell politically.

Some savings genuinely take time (e.g. new IT systems must be built first). But back-loading also delays the pain beyond the next election and makes targets easier to write into forecasts than to deliver — so they can quietly become real cuts later.

If demand is rising (e.g. an ageing population needing care) while the budget is fixed, even a genuinely more efficient service may not keep up. Output per pound rises, but output per person in need falls.

Many investors were not allowed to hold junk bonds, so they sold. Bond prices fell and yields rose, making new borrowing unaffordable. Greece was shut out of markets and had to turn to the Troika — on its terms. Higher yields also made the debt even less sustainable, a self-reinforcing spiral.

The UK borrows in its own currency and has its own central bank, which was buying gilts through QE — so there was almost no risk of it being unable to pay in pounds. Greece borrowed in euros it could not create, so investors faced a genuine risk of default.

Without a currency to devalue, the only way to become more competitive is to push down wages and prices directly. That means years of unemployment and falling incomes — and because debts are fixed in euros, falling incomes make them harder to repay.

The cuts were far deeper and faster, unemployment was more than three times higher, and the measures were seen as imposed by foreign creditors rather than chosen by Greek voters. The 2015 referendum result being overridden reinforced the sense that democracy had been ignored.