What Is Austerity?

Austerity is a topic that has generated significant visibility over the last several years as many countries used it to shore up their fiscal situation following the financial crisis. While definitions varying slightly, there are some common themes.

The Financial Times provides the following explanation:

"Austerity measures refer to official actions taken by the government, during a period of adverse economic conditions, to reduce its budget deficit using a combination of spending cuts or tax rises. Various austerity measures have been announced since the global recession in 2008 and the eurozone crisis in 2009."[1]

The Economist sheds further light on the subject, emphasizing that austerity measures aim to reduce the structural deficit, which is the difference between tax revenue and government spending that is created regardless of where the economy is in the business cycle.[2]

It is also worth noting that when a government cuts spending and or increases taxes, doing so may not balance the budget. In some cases, a nation's deficit may represent a high percentage of gross domestic product even after implementing austerity measures.

Why Is Austerity Needed?

Nations use austerity measures to get their budget deficits under control. Otherwise, these shortfalls will keep adding up, pushing the national debt higher. As this debt increases, paying interest on this obligation will require a steadily increasing budget expenditure. In addition, rising government debt can place upward pressure on the yields of government bonds.[3] The higher these yields go, the more a country will need to pay every time it wants to borrow money. In addition, rising yields could hinder private investment.

Why Trade Shares with FXCM?

  • $0.00 Commission*
  • Mini Shares - Fractional Share Trading with minimum trade sizes of 1/10 of a share.
  • Low Margin Requirements

If a nation faces ever-mounting debt, this development could make investors nervous and prevent them from buying the country's currency. In this instance, users of that native currency will need to pay more to buy foreign goods and services.

Why Do We Need Austerity Now?

After the financial crisis, a large number of nations operated with a substantial budget deficit.[4] The widespread incidence of these fiscal challenges created great concern, as many worried that any country running a sizable deficit was at risk of becoming like Greece.

Amid this perceived threat, many economists pointed to austerity measures as a promising remedy. While opponents argued these tactics would make matters worse for economies suffering challenges, advocates contended that having this kind of fiscal discipline would help bolster confidence. In 2010, nations across the world turned to austerity measures.

Why Should Investors Care?

Forex investors should be familiar with austerity, as well as its implications, for several reasons. First of all, any increases in taxes or reductions in government spending can have a major impact on a nation's economy. Also, as many economists have argued, austerity measures can easily affect the confidence of global market participants.[4] More specifically, these proponents have contended that if a country can trim its deficit, this fiscal responsibility can help bolster confidence, providing the economy with tailwinds.

Both the effect on economic conditions and the impact on investor confidence can play a key role in whether market participants flock to or shun a particular currency.

The Benefits of Austerity

Implementing austerity measures can benefit a country, and also its currency, in several ways. The merits of austerity are even more striking during a debt crisis, as a nation can help push interest rates lower by getting its fiscal house in order and alleviating concerns it will default on its debt.[5]

Reducing interest rates generally helps support economic growth. More specifically, it facilitates both investment and consumption in sectors that respond to significant changes in these borrowing costs. In addition, keeping budget deficits modest can help create the perception of stability, which in turn can produce foreign direct investment.

If global market participants believe a nation is stable, they will be more likely to buy its assets, which will probably help place upward pressure on the country's native currency.

The Costs of Austerity

While imposing austerity measures may produce numerous benefits, it can also generate costs. If a country raises taxes, doing so will put less money in people's pockets, placing downward pressure on both consumption and investment. The same result will likely come from cutting government expenditures.

In both of these instances, austerity measures could reduce a nation's growth and undermine its labor market. Spain, Portugal and Greece all implemented harsh austerity measures between 2009 and 2013, the final year of substantial budget cuts, and suffered economic contraction during that time.[4]

Government expenditures are a key component of GDP. When a nation opts to cut spending, doing so will increase its debt-to-GDP ratio, all things being equal.[5]

When this ratio is modest, it is a sign that a country has the ability to sell enough goods and services to pay off current debt without borrowing more money. However, if this ratio gets too high, investors may grow concerned about the nation's fiscal solvency, fleeing its assets and placing downward pressure on its native currency.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.

FXCM Research Team

FXCM Research Team consists of a number of FXCM's Market and Product Specialists.

Articles published by FXCM Research Team generally have numerous contributors and aim to provide general Educational and Informative content on Market News and Products.

References

1

Retrieved 14 Sep 2015 https://www.ft.com/

2

Retrieved 15 Sep 2015 https://www.economist.com/buttonwoods-notebook/2015/05/20/what-is-austerity

3

Retrieved 14 Sep 2015 https://www.economicshelp.org/blog/5366/economics/austerity-pros-and-cons/

4

Retrieved 14 Sep 2015 https://www.theguardian.com/business/ng-interactive/2015/apr/29/the-austerity-delusion

5

Retrieved 14 Sep 2015 https://www.richmondfed.org/-/media/richmondfedorg/publications/research/economic_brief/2013/pdf/eb_13-09.pdf

${getInstrumentData.name} / ${getInstrumentData.ticker} /

Exchange: ${getInstrumentData.exchange}

${getInstrumentData.bid} ${getInstrumentData.divCcy} ${getInstrumentData.priceChange} (${getInstrumentData.percentChange}%) ${getInstrumentData.priceChange} (${getInstrumentData.percentChange}%)

${getInstrumentData.oneYearLow} 52/wk Range ${getInstrumentData.oneYearHigh}
Disclosure
*

When executing customers' trades, FXCM can be compensated in several ways, which include, but are not limited to: spreads, charging commissions at the open and close of a trade, and adding a mark-up to rollover, etc. Commission-based pricing is applicable to Active Trader account types.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites contained on this website are provided on an "as-is" basis, as general market commentary and do not constitute investment advice. The market commentary has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and it is therefore not subject to any prohibition on dealing ahead of dissemination. Although this commentary is not produced by an independent source, FXCM takes all sufficient steps to eliminate or prevent any conflicts of interests arising out of the production and dissemination of this communication. The employees of FXCM commit to acting in the clients' best interests and represent their views without misleading, deceiving, or otherwise impairing the clients' ability to make informed investment decisions. For more information about the FXCM's internal organizational and administrative arrangements for the prevention of conflicts, please refer to the Firms' Managing Conflicts Policy. Please ensure that you read and understand our Full Disclaimer and Liability provision concerning the foregoing Information, which can be accessed here.

Past Performance: Past Performance is not an indicator of future results.

Spreads Widget: When static spreads are displayed, the figures reflect a time-stamped snapshot as of when the market closes. Spreads are variable and are subject to delay. Single Share prices are subject to a 15 minute delay. The spread figures are for informational purposes only. FXCM is not liable for errors, omissions or delays, or for actions relying on this information.