The Effect of Austerity Measures on Government Budget (Essay Sample)

By late 2009, Greece’s national debt had grown so large relative to the size of its economy that
lenders had lost confidence in the Greek government’s capacity to service it. Fear of a Greek
default led to contagion - Spain, Italy, Portugal, and Ireland were all subject to the disapproving
glare of frightened lenders. The crisis caused seismic disruption in Europe and the rest of the
world.
The International Monetary Fund, the European Commission, and the European Central
Bank reluctantly offered Greece bail-out loans - but with strings attached. To get the money,
Greece had to agree to austerity measures. In this context, austerity means tight fiscal
policy - that is, higher taxes and/or lower government spending to shrink Greece’s annual
budget deficit.
1. Using your knowledge of the impact of the government’s budget on the equilibrium level of
real GDP, and your understanding of the effect of the economy on the state of the
government’s budget, explain why austerity measures usually result in less improvement in
the government’s budget position than policymakers had hoped for. Be sure to define what
we mean by ‘the government’s budget.’